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MFS(R) INSTITUTIONAL TRUST
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JANUARY 1, 2001
PROSPECTUS
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This Prospectus describes three funds of the MFS Institutional Trust (referred
to as the Trust):
1. MFS INSTITUTIONAL LARGE CAP VALUE FUND (referred to as the Large Cap Value
Fund) seeks capital appreciation.
2. MFS INSTITUTIONAL INTERNATIONAL RESEARCH EQUITY FUND (referred to as the
International Research Fund) seeks capital appreciation.
3. MFS INSTITUTIONAL REAL ESTATE INVESTMENT FUND (referred to as the REIT Fund)
seeks as a main objective, capital appreciation; its secondary objective is
to provide current income and growth of income.
THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED THE
FUNDS' SHARES OR DETERMINED WHETHER THIS PROSPECTUS IS ACCURATE OR COMPLETE.
ANYONE WHO TELLS YOU OTHERWISE IS COMMITTING A CRIME.
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TABLE OF CONTENTS
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Page
I Expense Summary ............................................ 1
II Risk Return Summary ........................................ 2
1. Large Cap Value Fund ................................... 2
2. International Research Fund ............................ 4
3. REIT Fund .............................................. 6
III Certain Investment Strategies and Risks .................... 9
IV Management of the Funds .................................... 10
V Description of Shares ...................................... 11
VI How to Purchase, Exchange and Redeem Shares ................ 11
VII Other Information .......................................... 13
Appendix A -- Investment Techniques and Practices .......... A-1
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I EXPENSE SUMMARY
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o EXPENSE TABLE
This table describes the expenses that you may pay when you hold shares of
the funds.
ANNUAL FUND OPERATING EXPENSES (expenses that are deducted from fund
assets):
..........................................................................
LARGE INTERNAT
CAP IONAL
VALUE RESEARCH REIT
FUND FUND FUND
--- ------ ------
Management Fee ..............................0.60 % 0.75 % 0.70%
Other Expenses(1) ...........................0.20 % 0.26 % 0.28%
----- ----- -----
Total Annual Fund Operating Expenses ........0.80 % 1.01 % 0.98%
Fee Waiver/Expense Reimbursement(2) .....(0.25)% (0.16)% (0.18)%
----- ----- -----
Net Expenses(3) .........................0.55 % 0.85 % 0.80%
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(1) "Other Expenses" are based on estimated amounts for the current fiscal
year.
(2) MFS has contractually agreed to waive 0.05% of the Large Cap Value
Fund's management fee. MFS has contractually agreed to bear these
funds' expenses, such that "Other Expenses" (after taking into account
the expense offset arrangement below) do not exceed 0.00% for the Large
Cap Value Fund and 0.10% for the International Research Fund and the
REIT Fund. These contractual fee arrangements will continue until at
least January 1, 2002, unless changed with the consent of the board of
trustees which oversees the funds.
(3) Each fund has an expense offset arrangement which reduces the fund's
custodian fee based upon the amount of cash maintained by the fund with
its custodian and dividend disbursing agent. Each fund may enter into
other similar arrangements and directed brokerage arrangements, which
would also have the effect of reducing the fund's expenses. Any such
fee reductions are not reflected in the table. Had these fee reductions
been taken into account, "Net Expenses" would be lower.
o EXAMPLE OF EXPENSES
These examples are intended to help you compare the cost of investing in a
fund with the cost of investing in other mutual funds.
The examples assume that:
o You invest $10,000 in the fund for the time periods indicated and you
redeem your shares at the end of the time periods;
o Your investment has a 5% return each year and dividends and other
distributions are reinvested; and
o The fund's operating expenses remain the same, except that the fund's
total operating expenses are assumed to be the fund's "Net Expenses"
for the first year, and the fund's "Total Annual Fund Operating
Expenses" for subsequent years (see the table above).
Although your actual costs may be higher or lower, under these assumptions
your costs would be:
PERIOD
---------------------------------
SERIES 1 YEAR 3 YEARS
------------------------------------------------------------------------
Large Cap Value Fund $ 56 $ 230
International Research Fund 87 306
REIT Fund 82 294
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II RISK RETURN SUMMARY
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INVESTMENT STRATEGIES WHICH ARE COMMON TO ALL FUNDS ARE DESCRIBED UNDER
THE CAPTION "CERTAIN INVESTMENT STRATEGIES AND RISKS."
1: LARGE CAP VALUE FUND
..........................................................................
o INVESTMENT OBJECTIVES
The fund's investment objective is capital appreciation. This objective may
be changed without shareholder approval.
o PRINCIPAL INVESTMENT POLICIES
The fund invests, under normal market conditions, at least 65% of its total
assets in equity securities of large capitalization companies that the
fund's investment adviser, Massachusetts Financial Services Company
(referred to as MFS or the adviser), believes have sustainable growth
prospects and attractive valuations based on current and expected earnings
or cash flow. While the fund generally seeks to outperform the Russell 1000
Value Index with less volatility, and to perform in the top quartile of
comparable funds over three to five year time periods, there is no
assurance that the fund will achieve this goal. The Russell 1000 Value
Index measures the performance of those Russell 1000 companies with lower
price-to-book ratios and lower forecasted growth rates relative to the
companies in the Russell 1000 Growth Index. Equity securities include
common stocks and related securities, such as preferred stocks, convertible
securities and depositary receipts for those securities. While the fund may
invest in companies of any size, the fund generally focuses on companies
with large market capitalizations. Large capitalization companies are
defined as those companies with market capitalizations of at least $5
billion. Equity securities may be listed on a securities exchange or traded
in the over-the-counter markets.
MFS uses a bottom-up, as opposed to a top-down, investment style in
managing the equity-oriented funds (such as the fund) it advises. This
means that securities are selected based upon fundamental analysis (such as
an analysis of earnings, cash flows, competitive position and management's
abilities) performed by the fund's portfolio manager and MFS' large group
of equity research analysts.
The fund may invest in foreign securities through which it may have
exposure to foreign currencies.
o PRINCIPAL RISKS
The principal risks of investing in the fund and the circumstances
reasonably likely to cause the value of your investment in the fund to
decline are described below. The share price of the fund generally changes
daily based on market conditions and other factors. Please note that there
are many circumstances which could cause the value of your investment in
the fund to decline, and which could prevent the fund from achieving its
objective, that are not described here.
The principal risks of investing in the fund are:
o Market Risk: This is the risk that the price of a securitiy held by the
fund will fall due to changing economic, political or market conditions
or disappointing earnings results.
o Large-Cap Value Company Risk: Prices of value company securities held
by the fund may decline due to changing economic, political or market
conditions, or due to the financial condition of the company which
issued the security. If anticipated events do not occur or are delayed,
or if investor perceptions about the securities do not improve, the
market price of value securities may not rise as expected or may fall.
Large cap companies tend to go in and out of favor based on market and
economic conditions. Large cap companies tend to be less volatile than
companies with smaller market capitalizations. In exchange for this
potentially lower risk, the fund's value may not rise as much as the
value of funds that emphasize smaller cap companies.
o Foreign Markets Risk: Investing in foreign securities involves risks
relating to political, social and economic developments abroad, as well
as risks resulting from the differences between the regulations to
which U.S. and foreign issuers and markets are subject:
> These risks may include the seizure by the government of company
assets, excessive taxation, withholding taxes on dividends and
interest, limitations on the use or transfer of portfolio assets, and
political or social instability.
> Enforcing legal rights may be difficult, costly and slow in foreign
countries, and there may be special problems enforcing claims against
foreign governments.
> Foreign companies may not be subject to accounting standards or
governmental supervision comparable to U.S. companies, and there may
be less public information about their operations.
> Foreign markets may be less liquid and more volatile than U.S.
markets.
> Foreign securities often trade in currencies other than the U.S.
dollar, and the fund may directly hold foreign currencies and
purchase and sell foreign currencies through forward exchange
cntracts. Changes in currency exchange rates will affect the fund's
net asset value, the value of dividends and interest earned, and
gains and losses realized on the sale of securities. An increase in
the strength of the U.S. dollar relative to these other currencies
may cause the value of the fund to decline. Certain foreign
currencies may be particularly volatile, and foreign governments may
intervene in the currency markets, causing a decline in value or
liquidity in the fund's foreign currency holdings. By entering into
forward foreign currency exchange contracts, the fund may be required
to forego the benefits of advantageous changes in exchange rates and,
in the case of forward contracts entered into for the purpose of
increasing return, the fund may sustain losses which will reduce its
gross income. Forward foreign currency exchange contracts involve the
risk that the party with which the fund enters into the contract may
fail to perform its obligations to the fund.
o Active or Frequent Trading Risk: The fund may engage in active and
frequent trading to achieve its principal investment strategies. This
may result in the realization and distribution to shareholders of
higher net capital gains as compared to a fund with less active trading
policies, which would increase your tax liability. Frequent trading
also increases transaction costs, which could detract from the fund's
performance.
o As with any mutual fund, you could lose money on your investment in the
fund.
An investment in the fund is not a bank deposit and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other
government agency.
o BAR CHART AND PERFORMANCE TABLE
The bar chart and performance table are not included because the fund has
not had a full calendar year of investment operations.
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2: INTERNATIONAL RESEARCH FUND
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o INVESTMENT OBJECTIVE
The fund's investment objective is capital appreciation. This objective may
be changed without shareholder approval.
o PRINCIPAL INVESTMENT POLICIES
The fund invests, under normal market conditions, at least 65% of its total
assets in equity securities of foreign companies. Equity securities include
common stocks and related securities, such as preferred stocks, convertible
securities and depositary receipts for those securities. The fund focuses
on foreign companies (including emerging market issuers) that the fund's
investment adviser believes have favorable growth prospects and attractive
valuations based on current and expected earnings or cash flow. The fund
does not emphasize any particular country and may from time to time focus
its investments in individual countries or regions. Equity securities may
be listed on a securities exchange or traded in the over-the-counter
markets.
A committee of investment research analysts selects portfolio securities
for the fund. This committee includes investment analysts employed by MFS
and its investment advisory affiliates. The committee allocates the fund's
assets among various geographic regions and industries. Individual analysts
then select what they view as the securities best suited to achieve the
fund's investment objective within their assigned industry responsibility.
The fund may engage in active and frequent trading to achieve its
principal investment strategies.
o PRINCIPAL RISKS
The principal risks of investing in the fund and the circumstances
reasonably likely to cause the value of your investment in the fund to
decline are described below. The share price of the fund generally changes
daily based on market conditions and other factors. Please note that there
are many circumstances which could cause the value of your investment in
the fund to decline, and which could prevent the fund from achieving its
objective, that are not described here.
The principal risks of investing in the fund are:
o Market Risk: This is the risk that the price of a security held by the
fund will fall due to changing economic, political or market conditions
or disappointing earnings results.
o Company Risk: Prices of securities react to the economic condition of
the company that issued the security. The fund's equity investments in
an issuer may rise and fall based on the issuer's actual and
anticipated earnings, changes in management and the potential for
takeovers and acquisitions.
o Foreign Markets Risk: Investing in foreign securities involves risks
relating to political, social and economic developments abroad, as well
as risks resulting from the differences between the regulations to
which U.S. and foreign issuers and markets are subject:
> These risks may include the seizure by the government of company
assets, excessive taxation, withholding taxes on dividends and
interest, limitations on the use or transfer of portfolio assets, and
political or social instability.
> Enforcing legal rights may be difficult, costly and slow in foreign
countries, and there may be special problems enforcing claims against
foreign governments.
> Foreign companies may not be subject to accounting standards or
governmental supervision comparable to U.S. companies, and there may
be less public information about their operations.
> Foreign markets may be less liquid and more volatile than U.S.
markets.
> Foreign securities often trade in currencies other than the U.S.
dollar, and the fund may directly hold foreign currencies and
purchase and sell foreign currencies through forward exchange
contracts. Changes in currency exchange rates will affect the fund's
net asset value, the value of dividends and interest earned, and
gains and losses realized on the sale of securities. An increase in
the strength of the U.S. dollar relative to these other currencies
may cause the value of the fund to decline. Certain foreign
currencies may be particularly volatile, and foreign governments may
intervene in the currency markets, causing a decline in value or
liquidity in the fund's foreign currency holdings. By entering into
forward foreign currency exchange contracts, the fund may be required
to forego the benefits of advantageous changes in exchange rates and,
in the case of forward contracts entered into for the purpose of
increasing return, the fund may sustain losses which will reduce its
gross income. Forward foreign currency exchange contracts involve the
risk that the party with which the fund enters into the contract may
fail to perform its obligations to the fund.
o Emerging Markets Risk: Emerging markets are generally defined as
countries in the initial stages of their industrialization cycles with
low per capita income. The markets of emerging markets countries are
generally more volatile than the markets of developed countries with
more mature economies. All of the risks of investing in foreign
securities described above are heightened by investing in emerging
markets countries.
o Over-the-Counter Risk: Over-the-counter (OTC) transactions involve
risks in addition to those incurred by transactions in securities
traded on exchanges. OTC-listed companies may have limited product
lines, markets or financial resources. Many OTC stocks trade less
frequently and in smaller volume than exchange-listed stocks. The
values of these stocks may be more volatile than exchange-listed
stocks, and the fund may experience difficulty buying and selling these
stocks at prevailing market prices.
o Geographic Focus Risk: The fund may invest a substantial amount of its
assets in issuers located in a single country or a limited number of
countries. If the fund focuses its investments in this manner, it
assumes the risk that economic, political and social conditions in
those countries will have a significant impact on its investment
performance. The fund's investment performance may also be more
volatile if it focuses its investments in certain countries, especially
emerging market countries.
o Active or Frequent Trading Risk: The fund may engage in active and
frequent trading to achieve its principal investment strategies. This
may result in the realization and distribution to shareholders of
higher net capital gains as compared to a fund with less active trading
policies, which would increase your tax liability. Frequent trading
also increases transaction costs, which could detract from the fund's
performance.
o As with any mutual fund, you could lose money on your investment in the
fund.
An investment in the fund is not a bank deposit and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other
government agency.
o BAR CHART AND PERFORMANCE TABLE
The bar chart and performance table are not included because the fund has
not had a full calendar year of investment operations.
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3: REIT FUND
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o INVESTMENT OBJECTIVES
The fund's main investment objective is capital appreciation. Its secondary
objective is to provide current income and growth of income. These
objectives may be changed without shareholder approval.
o PRINCIPAL INVESTMENT POLICIES
The fund invests, under normal market conditions, at least 80% of its total
assets in securities of real estate investment trusts (REITs) and other
companies principally engaged in the real estate industry. REITs are pooled
investment vehicles that invest primarily in income producing real estate
or real estate related loans or interests. While the fund generally focuses
its investments in equity REITs, the fund may invest without restriction in
mortgage REITs. Equity REITs invest most of their assets directly in U.S.
or foreign real property, receive most of their income from rents and may
also realize gains by selling appreciated property. Mortgage REITs invest
most of their assets in real estate mortgages and receive most of their
income from interest payments. By investing in REITs indirectly through the
fund, a shareholder will bear not only a proportionate share of the
expenses of the fund, but also indirectly similar expenses of the REITs,
including compensation of management.
A company is considered to be principally engaged in the real estate
industry if, at the time of investment, the company earns at least 50% of
its gross revenues or net profits from real estate activities or from
products or services related to the real estate sector. Real estate
activities include owning, developing, managing or acting as a broker for
real estate. Examples of related products and services include building
supplies and mortgage servicing.
The fund's investments are allocated across various geographic areas,
REIT managers and property types, such as apartments, retail properties,
office buildings, hotels, industrial properties, health care facilities,
storage facilities, manufactured housing and special use facilities.
However, from time to time the fund may focus its investments in any one or
a few of these areas.
MFS has engaged Sun Capital Advisers, Inc. (referred to as Sun Capital
or the sub-adviser) to act as sub-adviser to the fund.
The sub-adviser selects securities for the fund's portfolio by analyzing
the fundamental and relative values of potential REIT investments based on
several factors, including:
o The ability of a REIT to grow its funds from operations internally
through increased occupancy and higher rents and externally through
acquisitions and development;
o The quality of a REIT's management, including its ability to buy
properties at reasonable prices and to add value by creative and
innovative property and business management;
o A REIT's cash flows, price/funds from operations ratio, dividend yield
and payment history, price/net asset value ratio and market price; and
o Current or anticipated economic and market conditions, interest rate
changes and regulatory developments.
Up to 20% of the fund's total assets may be invested in all types of
domestic and foreign equity and fixed income securities.
The fund is non-diversified. This means that the fund may invest a
relatively high percentage of its assets in a small number of issuers.
o PRINCIPAL RISKS
The principal risks of investing in the fund and the circumstances
reasonably likely to cause the value of your investment in the fund to
decline are described below. The share price of the fund generally changes
daily based on market conditions and other factors. Please note that there
are many circumstances which could cause the value of your investment in
the fund to decline, and which could prevent the fund from achieving its
objective, that are not described here.
The principal risks of investing in the fund are:
o Real Estate Risk: The risks of investing in real estate include risks
related to general, regional and local economic conditions and:
> fluctuations in interest rates;
> overbuilding and increased competition;
> increases in property taxes and operating expenses;
> changes in zoning laws;
> heavy cash flow dependency;
> possible lack of availability of mortgage funds;
> losses due to natural disasters;
> regulatory limitations on rents;
> variations in market rental rates;
> changes in neighborhood property values; and
> environmental problems
Furthermore, a REIT in the fund's portfolio may be, or may be
perceived by the market to be, poorly managed, or the sub-adviser's
judgments about the relative values of REIT securities selected for
the fund's portfolio may prove to be wrong.
Equity REITs may be affected by changes in the value of the
underlying property owned by the trusts. Mortgage REITs may be
affected by default or payment problems relating to underlying
mortgages, the quality of credit extended and self-liquidation
provisions by which mortgages held may be paid in full and
distributions of capital returns may be made at any time. Equity and
mortgage REITs could be adversely affected by failure to qualify for
tax-free pass-through of income under the Internal Revenue Code of
1986, as amended, or to maintain their exemption from registration
under the Investment Company Act of 1940, as amended. Also, to the
extent the fund invests in mortgage REITs, it will be subject to
credit risk and interest rate risk, described below.
o Credit Risk: Credit risk is the risk that the issuer of a fixed income
security will not be able to pay principal and interest when due.
Rating agencies assign credit ratings to certain fixed income
securities to indicate their credit risk. The price of a fixed income
security will generally fall if the issuer defaults on its obligation
to pay principal or interest, the rating agencies downgrade the
issuer's credit rating or other news affects the market's perception of
the issuer's credit risk.
o Interest Rate Risk: When interest rates rise, the prices of fixed
income securities in the fund's portfolio will generally fall.
Conversely, when interest rates fall, the prices of fixed income
securities in the fund's portfolio will generally rise.
o Concentration Risk: The fund's investment performance will be closely
tied to the performance of companies in the real estate group of
industries. Companies in a single industry often are faced with the
same obstacles, issues and regulatory burdens, and their securities may
react similarly and more in unison to these or other market conditions.
These price movements may have a larger impact on the fund than on a
fund with a more broadly diversified portfolio.
o Non-Diversified Status Risk: Because the fund may invest its assets in
a small number of issuers, the fund is more susceptible to any single
economic, political or regulatory event affecting those issuers than is
a diversified fund.
o Foreign Markets Risk: Investments in foreign securities involve risks
relating to political, social and economic developments abroad, as well
as risks resulting from the differences between the regulations to
which U.S. and foreign issuers and markets are subject:
> These risks may include the seizure by the government of company
assets, excessive taxation, withholding taxes on dividends and
interest, limitations on the use or transfer of portfolio assets, and
political or social instability.
> Enforcing legal rights may be difficult, costly and slow in foreign
countries, and there may be special problems enforcing claims against
foreign governments.
> Foreign companies may not be subject to accounting standards or
governmental supervision comparable to U.S. companies, and there may
be less public information about their operations.
> Foreign markets may be less liquid and more volatile than U.S.
markets.
> Foreign securities often trade in currencies other than the U.S.
dollar, and the fund may directly hold foreign currencies and
purchase and sell foreign currencies through forward exchange
contracts. Changes in currency exchange rates will affect the fund's
net asset value, the value of dividends and interest earned, and
gains and losses realized on the sale of securities. An increase in
the strength of the U.S. dollar relative to these other currencies
may cause the value of the fund to decline. Certain foreign
currencies may be particularly volatile, and foreign governments may
intervene in the currency markets, causing a decline in value or
liquidity in the fund's foreign currency holdings. By entering into
forward foreign currency exchange contracts, the fund may be required
to forego the benefits of advantageous changes in exchange rates and,
in the case of forward contracts entered into for the purposes of
increasing return, the fund may sustain losses which will reduce its
gross income. Forward foreign currency exchange contracts involve the
risk that the party with which the fund enters into the contract may
fail to perform its obligations to the fund.
o Small Cap Companies Risk: Many REITs are small capitalization
companies. Investments in small cap companies tend to involve more risk
and be more volatile than investments in larger companies. Small cap
companies may be more susceptible to market declines because of their
limited financial and management resources, markets and distribution
channels. Their shares may be more difficult to sell at satisfactory
prices during market declines.
o Active or Frequent Trading Risk: The fund may engage in active and
frequent trading to achieve its principal investment strategies. This
may result in the realization and distribution to shareholders of
higher net capital gains as compared to a fund with less active trading
policies, which would increase your tax liability. Frequent trading
also increases transaction costs, which could detract from the fund's
performance.
o As with any mutual fund, you could lose money on your investment in the
fund.
An investment in the fund is not a bank deposit and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other
government agency.
o BAR CHART AND PERFORMANCE TABLE
The bar chart and performance table are not included because the fund has
not had a full calendar year of investment operations.
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III CERTAIN INVESTMENT STRATEGIES AND RISKS
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o FURTHER INFORMATION ON INVESTMENT STRATEGIES AND RISKS
Each fund may invest in various types of securities and engage in various
investment techniques and practices which are not the principal focus of
the fund and therefore are not described in this prospectus. The types of
securities and investment techniques and practices in which a fund may
engage, including the principal investment techniques and practices
described above, are identified in Appendix A to this prospectus, and are
discussed, together with their risks, in the funds' Statement of Additional
Information (referred to as the SAI), which you may obtain by contacting
MFS Service Center, Inc. (please see back cover for address and telephone
number).
o TEMPORARY DEFENSIVE POLICIES
In addition, each fund may depart from its principal investment strategies
by temporarily investing for defensive purposes when adverse market,
economic or political conditions exist. While a fund invests defensively,
it may not be able to pursue its investment objective. The fund's defensive
investment position may not be effective in protecting its value.
o ACTIVE OR FREQUENT TRADING
Each fund may engage in active and frequent trading to achieve its
principal investment strategies. This may result in the realization and
distribution to shareholders of higher capital gains as compared to a fund
with less active trading policies, which would increase your tax liability.
Frequent trading also increases transaction costs, which could detract from
the fund's performance.
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IV MANAGEMENT OF THE FUNDS
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o INVESTMENT ADVISER
Massachusetts Financial Services Company (referred to as MFS or the
adviser) is the funds' investment adviser. MFS is America's oldest mutual
fund organization. MFS and its predecessor organizations have a history of
money management dating from 1924 and the founding of the first mutual
fund, Massachusetts Investors Trust. Net assets under the management of the
MFS organization were approximately $137.95 billion as of November 30,
2000. MFS is located at 500 Boylston Street, Boston, Massachusetts 02116.
MFS provides investment management and related administrative services
and facilities to each fund, including portfolio management and trade
execution. For these services, each fund pays MFS an annual management fee.
The effective rate of the management fee paid by each fund to MFS is
reflected in the "Expense Table."
o SUB-INVESTMENT ADVISER
The adviser has engaged a sub-adviser for the REIT Fund: Sun Capital
Advisers, Inc., referred to as Sun Capital or the sub-adviser. The
sub-adviser is an affiliate of the adviser. Sun Capital is an indirect
wholly-owned subsidiary of Sun Life Assurance Company of Canada, an
insurance company. The sub-adviser's investment personnel are also employed
in the U.S. Investment Division of Sun Life Assurance Company of Canada.
The sub-adviser has been providing investment management and supervisory
services to pension and profit-sharing accounts since 1997 and to mutual
funds since 1998. Sun Capital is located at One Sun Life Executive Park,
Wellesley Hills, Massachusetts 02481. For its services, MFS pays the
sub-adviser a management fee in an amount equal to 0.35% annually of the
average daily net asset value of the REIT Fund's assets managed by the
sub-adviser. The REIT Fund is not responsible for paying a subadvisory fee
directly.
o PORTFOLIO MANAGERS
FUND PORTFOLIO MANAGERS
---- ------------------
Large Cap Value Fund Lisa B. Nurme, a Senior Vice President of
MFS, has been employed in the investment
management area of the adviser since 1987 and
has been the portfolio manager of the fund
since its inception.
International Research Fund The fund is managed by a committee of various
equity research analysts employed by the
adviser under the general oversight of David
A. Antonelli, the Director of International
Research and a Senior Vice President of the
adviser. Mr. Antonelli has been employed in
the investment management area of MFS since
1991.
REIT Fund The fund is managed by Sun Capital. John T.
Donnelly is a Senior Vice President of Sun
Capital. Joseph H. Bozoyan is a Vice
President of Sun Capital. Thomas V. Pedulla
is a Senior Vice President of Sun Capital.
All three portfolio managers have been
employed in the investment management area of
Sun Capital's parent, Sun Life Assurance
Company of Canada, since 1994. All three have
co-managed the fund since its inception.
o ADMINISTRATOR
MFS provides the funds with certain financial, legal, compliance,
shareholder communications and other administrative services. MFS is
reimbursed by the funds for a portion of the costs it incurs in providing
these services.
o SHAREHOLDER SERVICING AGENT
MFS Service Center, Inc. (referred to as MFSC), a wholly owned subsidiary
of MFS, performs transfer agency and certain other services for the funds,
for which it is entitled to receive compensation from the funds.
<PAGE>
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V DESCRIPTION OF SHARES
------------------------
Each fund is designed for sale to institutional investor clients of MFS and
MFS Institutional Advisors, Inc. and other similar investors. Each fund
offers a single class of shares, which are not subject to a sales charge or
any Rule 12b-1 distribution and service fees.
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VI HOW TO PURCHASE, EXCHANGE AND REDEEM SHARES
----------------------------------------------
You may purchase, exchange and redeem shares of a fund in the manner
described below.
o HOW TO PURCHASE SHARES
Shares may be purchased through MFD in cash or in-kind without a sales
charge at their net asset value next computed after acceptance of the
purchase order. The minimum initial investment is generally $3 million
(generally $1 million in the case of purchases by bank trust departments
for their clients). There is no minimum on additional investments.
OPENING AN ACCOUNT: Payments by check should be made to the order of
[insert name of fund] and sent to that particular fund as follows: MFS
Service Center, Inc., P.O. Box 1400, Boston, MA 02107-9906. Payments of
federal funds should be sent by wire to the custodian of the fund as
follows: State Street Bank and Trust Company, Attn: Mutual Funds Division,
for the account of: [Shareholder's name], Re: [insert name of fund]
(Account No. 99034795) and Wire Number: [Assigned by telephone].
Information on how to wire federal funds is available at any national
bank or any state bank which is a member of the Federal Reserve System.
Shareholders should also mail the completed Account Application to the
MFSC.
A shareholder must first telephone MFSC (see back cover for telephone
number) to advise of its intended action and, if funds are to be wired, to
obtain a wire order number.
IN-KIND PURCHASES: Shares of each fund may be purchased with securities
acceptable to that particular fund. A fund need not accept any security
offered for an in-kind purchase unless it is consistent with that fund's
investment objective, policies and restrictions and is otherwise acceptable
to the fund. Securities accepted in-kind for shares will be valued in
accordance with the fund's usual valuation procedures (see "Net Asset
Value" below). Investors interested in making an in-kind purchase of fund
shares must first telephone MFSC (see back cover for telephone number) to
advise of its intended action and obtain instructions for an in-kind
purchase.
o HOW TO EXCHANGE SHARES
You can exchange your shares for shares of any of the other funds described
in this prospectus at net asset value by contacting MFSC (see back cover
for telephone number). Exchanges will be made only after instructions in
writing or by telephone (an "Exchange Request") are received for an
established account by MFSC in proper form (see "Redemptions" below). If
you use an Exchange Request to open a new account with one of the other
funds described in this prospectus, the exchange must involve shares having
an aggregate value of at least $3 million (generally $1 million in the case
of purchases by bank trust departments for their clients).
Exchanges may be subject to certain limitations and are subject to the
MFS funds' policies concerning excessive trading practices, which are
policies designed to protect the funds and their shareholders from the
harmful effect of frequent exchanges. These limitations and market timing
policies are described below under the captions "Right to Reject or
Restrict Purchase and Exchange Orders" and "Excessive Trading Practices."
You should read the description of the fund into which you are exchanging
and consider the differences in objectives, policies and rules before
making any exchange.
o HOW TO REDEEM SHARES
You may redeem your shares by contacting the MFSC. Redemptions may be in
cash or, at the fund's discretion, by distribution in-kind of securities
from a fund's portfolio. The securities distributed are selected by MFS in
light of the fund's objective and may not represent a pro rata distribution
of each security held in the fund's portfolio. In the event that a fund
makes an in-kind distribution, you could incur the brokerage and
transaction charges when converting the securities to cash. The fund sends
out your redemption proceeds within seven days after your request is
received in good order. "Good order" generally means that the stock power,
written request for redemption, letter of instruction or certificate must
be endorsed by the record owner(s) exactly as the shares are registered. In
addition, you need to have your signature guaranteed and/or submit
additional documentation to redeem your shares. See "Signature Guarantee/
Additional Documentation" below, or contact MFSC for details (see back
cover page for address and phone number).
Under unusual circumstances such as when the New York Stock Exchange is
closed, trading on the Exchange is restricted or if there is an emergency,
a fund may suspend redemptions or postpone payment. If you purchased the
shares you are redeeming by check, a fund may delay the payment of the
redemption proceeds until the check has cleared, which may take up to 15
days from the purchase date.
Each fund reserves the right to redeem shares in your account for their
then-current value (which you will be promptly paid) if at any time the
total investment in the account drops below $500,000 because of redemptions
and exchanges. You will be notified when the value of the account is less
than the minimum investment requirement and allowed 60 days to make an
additional investment before the redemption is processed.
REDEEMING DIRECTLY THROUGH MFSC.
o BY TELEPHONE. You can call MFSC to have shares redeemed from your
account and the proceeds wired or mailed (depending on the amount
redeemed) directly to a pre-designated bank account. MFSC will request
personal or other information from you and will generally record the
calls. MFSC will be responsible for losses that result from
unauthorized telephone transactions if it does not follow reasonable
procedures designed to verify your identity. You must elect this
privilege on your account application if you wish to use it.
o BY MAIL. To redeem shares by mail, you can send a letter to MFSC with
the name of your fund, your account number, and the number of shares or
dollar amount to be sold.
SIGNATURE GUARANTEE/ADDITIONAL DOCUMENTATION. In order to protect against
fraud, each fund requires that your signature be guaranteed in order to
redeem your shares. Your signature may be guaranteed by an eligible bank,
broker, dealer, credit union, national securities exchange, registered
securities association, clearing agency, or savings association. MFSC may
require additional documentation for certain types of registrations and
transactions. Signature guarantees and this additional documentation shall
be accepted in accordance with policies established by MFSC, and MFSC may
make certain de minimis exceptions to these requirements.
o OTHER CONSIDERATIONS
RIGHT TO REJECT OR RESTRICT PURCHASE AND EXCHANGE ORDERS. Purchases and
exchanges should be made for investment purposes only. Each fund reserves
the right to reject or restrict any specific purchase or exchange request.
Because an exchange request involves both a request to redeem shares of one
fund and to purchase shares of another fund, the funds consider the
underlying redemption and purchase requests conditioned upon the acceptance
of each of these underlying requests. Therefore, in the event that the
funds reject an exchange request, neither the redemption nor the purchase
side of the exchange will be processed. When a fund determines that the
level of exchanges on any day may be harmful to its remaining shareholders,
the fund may delay the payment of exchange proceeds for up to seven days to
permit cash to be raised through the orderly liquidation of its portfolio
securities to pay the redemption proceeds. In this case, the purchase side
of the exchange will be delayed until the exchange proceeds are paid by the
redeeming fund.
EXCESSIVE TRADING PRACTICES. The funds do not permit market-timing or other
excessive trading practices. Excessive, short-term (market-timing) trading
practices may disrupt portfolio management strategies and harm fund
performance. As noted above, each fund reserves the right to reject or
restrict any purchase order (including exchanges) from any investor. To
minimize harm to a fund and its shareholders, a fund will exercise these
rights if an investor has a history of excessive trading or if an
investor's trading, in the judgment of the fund, has been or may be
disruptive to a fund. In making this judgment, a fund may consider trading
done in multiple accounts under common ownership or control.
<PAGE>
---------------------
VII OTHER INFORMATION
---------------------
o PRICING OF FUND SHARES
The price of each fund's shares is based on its net asset value. The net
asset value of each fund's shares is determined at the close of regular
trading each day that the New York Stock Exchange ("NYSE") is open for
trading (generally, 4:00 p.m., Eastern time) (referred to as the valuation
time). The NYSE is closed for business on most national holidays and Good
Friday. To determine net asset value, each fund values its assets at
current market values, or, if current market values are unavailable, at
fair value as determined by the adviser under the direction of the Board of
Trustees that oversees the fund. Fair value pricing may be used by a fund
when current market values are unavailable or when an event occurs after
the close of the exchange on which the fund's portfolio securities are
principally traded that is likely to have changed the value of the
securities. The use of fair value pricing by a fund may cause the net asset
value of its shares to differ significantly from the net asset value that
would be calculated using current market values.
Certain of the funds invest in securities which are primarily listed on
foreign exchanges that trade on weekends and other days when the fund does
not price its shares. Therefore, the value of the fund's shares may change
on days when you will not be able to purchase or redeem the funds' shares.
o DISTRIBUTIONS
Each fund intends to declare and pay substantially all of its net
investment income (including any realized net capital gains) to its
shareholders as dividends at least annually.
o TAX CONSIDERATIONS
The following discussion is very general. You are urged to consult your tax
adviser regarding the effect that an investment in a fund may have on your
particular tax situation.
TAXABILITY OF DISTRIBUTIONS. As long as a fund qualifies for treatment as a
regulated investment company (which each fund intends to do), it pays no
federal income tax on the earnings and gains it distributes to its
shareholders.
You will normally have to pay federal income tax, and any state or local
income taxes, on the distributions you receive from a fund, whether you
take the distributions in cash or reinvest them in additional shares.
Distributions designated as capital gain dividends are taxable as long-term
capital gains. Other distributions are generally taxable as ordinary
income. Distributions derived from interest on U.S. Government securities
(but not distributions of gains from the sale of those securities) may be
exempt from state and local personal income taxes. Some dividends paid in
January may be taxable as if they had been paid the previous December.
The Form 1099 that is mailed to you every January details your
distributions and how they are treated for federal income tax purposes.
All distributions by each fund will reduce its net asset value per share.
Therefore, if you buy shares shortly before the record date of a
distribution, you will pay the full price for the shares and then
effectively may receive a portion of the purchase price back as a taxable
distribution.
If you are neither a citizen nor a resident of the United States, a fund
will withhold U.S. federal income tax at the rate of 30% on income
dividends and other payments that are subject to such withholding. You may
be able to arrange for a lower withholding rate under an applicable tax
treaty if you supply the appropriate documentation required by the fund.
Each fund is also required in certain circumstances to apply backup
withholding at the rate of 31% on dividends and redemption proceeds paid to
any shareholder (including a shareholder who is nether a citizen nor a
resident of the United States) who does not furnish to the fund certain
information and certifications or, in the case of dividends, who is
otherwise subject to backup withholding. Backup withholding will not,
however, be applied to payments that have been subject to 30% withholding.
Prospective investors in a fund should read its Account Application for
additional information regarding backup withholding of federal income tax.
TAXABILITY OF TRANSACTIONS. When you redeem or exchange shares, it is
considered a taxable event for you. Depending on the purchase price and the
redemption price of the shares you redeem, sell or exchange, you may have a
gain or a loss on the transaction. You are responsible for any tax
liabilities generated by your transaction.
o UNIQUE NATURE OF SERIES
MFS may serve as the investment adviser to other funds which have
investment goals and principal investment policies and risks similar to
those of the funds, and which may be managed by a fund's portfolio
manager(s). While a fund may have many similarities to these other funds,
its investment performance will differ from their investment performance.
This is due to a number of differences between a fund and these similar
products, including differences in sales charges, expense ratios and cash
flows.
<PAGE>
----------
APPENDIX A
----------
o INVESTMENT TECHNIQUES AND PRACTICES
In pursuing its investment objective, each fund may engage in the following
principal and non-principal investment techniques and practices. Investment
techniques and practices which are the principal focus of a fund are
described, together with their risks, in the Risk Return Summary of the
Prospectus. Both principal and non-principal investment techniques and
practices are described, together with their risks, in the SAI.
<TABLE>
<CAPTION>
INVESTMENT TECHNIQUES/PRACTICES
...........................................................................................
SYMBOLS x permitted -- not permitted
-------------------------------------------------------------------------------------------
INTERNATIONAL
LARGE CAP RESEARCH
VALUE FUND FUND REIT FUND
---------- -------------- ---------
<S> <C> <C> <C>
Debt Securities
Asset-Backed Securities
Collateralized Mortgage Obligations and
Multiclass Pass-Through Securities x -- x
Corporate Asset-Backed Securities x -- x
Mortgage Pass-Through Securities x x x
Stripped Mortgage-Backed Securities x -- x
Corporate Securities x x x
Loans and Other Direct Indebtedness x -- x
Lower Rated Bonds x -- x
Municipal Bonds x -- x
Speculative Bonds x -- x
U.S. Government Securities x x x
Variable and Floating Rate Obligations x -- x
Zero Coupon Bonds, Deferred Interest Bonds
and PIK Bonds x -- x
Equity Securities x x x
Foreign Securities Exposure
Brady Bonds x -- x
Depositary Receipts x x x
Dollar-Denominated Foreign Debt Securities x x x
Emerging Markets x x x
Foreign Securities x x x
Forward Contracts x x x
Futures Contracts x x x
Indexed Securities/Structured Products x x x
Inverse Floating Rate Obligations -- -- --
Investment in Other Investment Companies
Open-End Funds x x x
Closed-End Funds x x x
Lending of Portfolio Securities x x x
Leveraging Transactions
Bank Borrowings -- -- --
Mortgage "Dollar-Roll" Transactions x -- x
Reverse Repurchase Agreements -- -- --
Options
Options on Foreign Currencies x x x
Options on Futures Contracts x x x
Options on Securities x x x
Options on Stock Indices x x x
Reset Options x x x
"Yield Curve" Options x x x
Repurchase Agreements x x x
Restricted Securities x x x
Short Sales -- -- x
Short Sales Against the Box -- -- x
Short Term Instruments x x x
Swaps and Related Derivative Instruments x -- x
Temporary Borrowings x x x
Temporary Defensive Positions x x x
Warrants x x x
"When-Issued" Securities x x x
* May only be changed with shareholder approval.
</TABLE>
<PAGE>
MFS(R) INSTITUTIONAL TRUST
If you want more information about the funds, the following documents are
available free upon request:
ANNUAL/SEMIANNUAL REPORTS. These reports contain information about the funds'
actual investments. Annual reports discuss the effect of recent market
conditions and the funds' investment strategy on the funds' performance during
their last fiscal year.
STATEMENT OF ADDITIONAL INFORMATION (SAI). The SAI, dated January 1, 2001,
provides more detailed information about the funds and is incorporated into this
prospectus by reference.
YOU CAN GET FREE COPIES OF THE ANNUAL/SEMIANNUAL REPORTS, THE SAI AND OTHER
INFORMATION ABOUT THE FUNDS, AND MAKE INQUIRIES ABOUT THE FUNDS, BY CONTACTING:
MFS Service Center, Inc.
2 Avenue de Lafayette
Boston, MA 02111-1738
Telephone: 1-800-637-2262
Internet: http://www.mfs.com
Information about the funds (including their prospectus, SAI and shareholder
reports) can be reviewed and copied at the:
Public Reference Room
Securities and Exchange Commission
Washington, D.C., 20549-0102
Information on the operation of the Public Reference Room may be obtained by
calling the Commission at 1-202-942-8090. Reports and other information about
the funds are available on the EDGAR Databases on the Commission's Internet
website at http://www.sec.gov, and copies of this information may be obtained,
upon payment of a duplicating fee, by electronic request at the following e-mail
address: [email protected], or by writing the Public Reference Section at the
above address.
The Trust's Investment Company Act file number is 811-6174.
[Union logo] MFSIT-1 12/00 1M
<PAGE>
MFS(R) INSTITUTIONAL TRUST
JANUARY 1, 2001
[logo] M F S(R) STATEMENT OF ADDITIONAL
INVESTMENT MANAGEMENT INFORMATION
We invented the mutual fund(R)
MFS(R) INSTITUTIONAL TRUST
500 BOYLSTON STREET, BOSTON, MA 02116
(617) 954-5000
This Statement of Additional Information, as amended or supplemented from time
to time (the "SAI"), sets forth information which may be of interest to
investors but which is not necessarily included in the Funds' Prospectus dated
January 1, 2001, as supplemented from time to time. This SAI should be read in
conjunction with the Prospectus, a copy of which may be obtained without charge
by contacting MFS Service Center, Inc. (see back cover for address and phone
number).
This SAI relates to the three Funds identified on page three hereof. Shares of
these Funds are designed for sale to institutional investor clients of MFS and
MFS Institutional Advisors, Inc., a wholly owned subsidiary of MFS, and other
similar investors.
THIS SAI IS NOT A PROSPECTUS AND IS AUTHORIZED FOR DISTRIBUTION TO PROSPECTIVE
INVESTORS ONLY IF PRECEDED OR ACCOMPANIED BY A CURRENT PROSPECTUS.
MFSIT-13 12/00 500
<PAGE>
-----------------
TABLE OF CONTENTS
-----------------
Page
I Definitions ................................................... 3
II Investment Techniques, Practices and Risks .................... 3
III Investment Restrictions ....................................... 3
IV Management of the Funds ....................................... 4
Trustees .................................................. 4
Officers .................................................. 4
Trustees Compensation Table ............................... 5
Investment Adviser ........................................ 5
Investment Advisory Agreement ............................. 5
Administrator ............................................. 6
Custodian ................................................. 7
Shareholder Servicing Agent ............................... 7
Distributor ............................................... 7
V Portfolio Transactions and Brokerage Commissions .............. 7
VI Tax Considerations ............................................ 9
VII Net Income and Distributions .................................. 10
VIII Determination of Net Asset Value .............................. 10
IX Performance Information ....................................... 11
X Descriptions of Shares, Voting Rights and Liabilities ......... 13
XI Independent Auditors and Financial Statements ................. 14
Appendix A -- Investment Techniques, Practices and Risks ...... A-1
Appendix B -- Description of Bond Ratings ..................... B-1
Appendix C -- Performance Quotation ........................... C-1
<PAGE>
I DEFINITIONS
"Trust" - MFS Institutional Trust, a Massachusetts business trust organized
on September 13, 1990.
"Large Cap Value Fund" - MFS Institutional Large Cap Value Fund, a
diversified series of the Trust.*
"International Research Fund" - MFS Institutional International Research
Equity Fund, a diversified series of the Trust.*
"REIT Fund" - MFS Institutional Real Estate Investment Fund, a
non-diversified series of the Trust.
"Funds" - Large Cap Value Fund, International Research Fund and REIT Fund.
"MFS" or the "Adviser" - Massachusetts Financial Services Company, a
Delaware corporation.
"MFD" - MFS Fund Distributors, Inc., a Delaware corporation.
"Sub-Adviser" -- Sun Capital Advisers, Inc., a Delaware corporation.
"MFSC" MFS Service Center, Inc., a Delaware corporation.
"Prospectus" - The Prospectus of the Funds, dated January 1, 2001, as
amended or supplemented from time to time.
----------------
* Diversified series of the Trust. This means that, with respect to 75% of
its total assets, the series may not (1) purchase more than 10% of the
outstanding voting securities of any one issuer, or (2) purchase
securities of any issuer if, as a result, more than 5% of the series'
total assets would be invested in that issuer's securities. This
limitation does not apply to obligations of the U.S. Government or its
agencies or instrumentalities.
II INVESTMENT TECHNIQUES, PRACTICES AND RISKS
The investment objective and principal investment policies of each Fund are
described in the Prospectus. In pursuing its investment objective and
principal investment policies, a Fund may engage in a number of investment
techniques and practices, which involve certain risks. These investment
techniques and practices, which may be changed without shareholder approval
unless indicated otherwise, are identified in Appendix A to the Prospectus,
and are more fully described, together with their associated risks, in
Appendix A to this SAI. The following percentage limitations (as a
percentage of net assets) apply to these investment techniques and
practices:
PERCENTAGE LIMITATION
INVESTMENT POLICY (BASED ON NET ASSETS)
----------------- ---------------------
1. LARGE CAP VALUE FUND
Foreign Securities: .......... 25%
Lower Rated Bonds: ........... up to (but not including) 20%
Securities Lending: .......... 30%
Options*: .................... 5%
2. INTERNATIONAL RESEARCH FUND
Emerging Market Securities: .. 25%
Securities Lending: .......... 30%
Options*: .................... 5%
3. REIT FUND
Securities Lending: .......... 30%
Foreign Securities: .......... 20%
Options*: .................... 5%
* Investing in Options is not a principal focus of any of the Funds.
III INVESTMENT RESTRICTIONS
INVESTMENT RESTRICTIONS. The Trust on behalf of each Fund has adopted the
following fundamental and non-fundamental investment restrictions.
Fundamental restrictions cannot be changed without the approval of the
holders of a majority of that Fund's shares (which, as used in this SAI,
means the lesser of (i) more than 50% of its outstanding shares, or (ii)
67% or more of its outstanding shares present at a meeting at which holders
of more than 50% of its outstanding shares are represented in person or by
proxy).
Except for Investment Restriction (1) and each Fund's non-fundamental
investment policy regarding investing in illiquid securities, these
investment restrictions and policies are adhered to at the time of purchase
or utilization of assets; a subsequent change in circumstances will not be
considered to result in a violation of policy. In the event of a violation
of nonfundamental policy (1), the fund will reduce the percentage of its
assets invested in illiquid investments in due course, taking into account
the best interests of shareholders.
As fundamental policies, each Fund may not:
(1) Borrow amounts in excess of 3313% of its assets including
amounts borrowed.
(2) Underwrite securities issued by other persons except insofar as
the Fund may technically be deemed an underwriter under the Securities
Act of 1933 in selling a portfolio security.
(3) Purchase or sell real estate (including limited partnership
interests but excluding securities secured by real estate or interests
therein and securities of companies, such as real estate investment
trusts, which deal in real estate or interests therein), interests in
oil, gas or mineral leases, commodities or commodity contracts
(excluding Options, Options on Futures Contracts, Options on Stock
Indices, Options on Foreign Currencies and any other type of option,
and Futures Contracts) in the ordinary course of its business; however,
each Fund reserves the freedom of action to hold and to sell real
estate, mineral leases, commodities or commodity contracts (including
Options, Options on Futures Contracts, Options on Stock Indices,
Options on Foreign Currencies and any other type of option, and Futures
Contracts) acquired as a result of the ownership of securities.
(4) Issue any senior securities except as permitted by the
Investment Company Act of 1940 ("1940 Act"). For purposes of this
restriction, collateral arrangements with respect to any type of option
(including Options, Options on Futures Contracts, Options on Stock
Indices, Options on Foreign Currencies), Forward Contracts, Futures
Contracts and swap and collateral arrangements with respect to initial
and variation margin are not deemed to be the issuance of a senior
security.
(5) Make loans to other persons. For these purposes, the purchase of
short-term commercial paper, the purchase of a portion or all of an
issue of debt securities, the lending of portfolio securities, or the
investment of a Fund's assets in repurchase agreements, shall not be
considered the making of a loan.
(6) Purchase any securities of an issuer of a particular industry,
if, as a result, 25% or more of its gross assets would be invested in
securities of issuers whose principal business activities are in the
same industry (except obligations issued or guaranteed by the U.S.
Government or its agencies and instrumentalities and repurchase
agreements collateralized by such obligations), except that the REIT
Fund will invest at least 25% or more of its total assets in the real
estate group of industries.
In addition, the Funds have adopted the following non-fundamental policies
which may be changed without shareholder approval. Each such Fund will not:
(1) Invest in illiquid investments, including securities subject to
legal or contractual restrictions on resale or for which there is no
readily available market (e.g., trading in the security is suspended,
or, in the case of unlisted securities, where no market exists) if more
than 15% of the Fund's net assets (taken at market value) would be
invested in such securities. Repurchase agreements maturing in more
than seven days will be deemed to be illiquid for purposes of a Fund's
limitation on investment in illiquid securities. Securities that are
not registered under the Securities Act of 1933, as amended, and sold
in reliance on Rule 144A thereunder, but are determined to be liquid by
the Trust's Board of Trustees (or its delegee), will not be subject to
this 15% limitation.
(2) Invest for the purpose of exercising control or management.
IV MANAGEMENT OF THE FUNDS
The Board of Trustees of the Trust provides broad supervision over the
affairs of each Fund. MFS is responsible for the investment management of
each Fund's assets and the officers of the Trust are responsible for its
operations. The Trustees and officers are listed below, together with their
principal occupations during the past five years (their titles may have
varied during that period).
The Funds and their Adviser and Distributor, and the Sub-Adviser, have
adopted codes of ethics as required under the 1940 Act. Subject to certain
conditions and restrictions, these codes permit personnel subject to the
codes to invest in securities for their own accounts, including securities
that may be purchased, held or sold by a Fund. Securities transactions by
some of these persons may be subject to prior approval of the Adviser's or
Sub-Adviser's compliance departments. Securities transactions of certain
personnel are subject to quarterly reporting and review requirements. The
codes are on public file with, and are available from, the SEC. See the
back cover of the Prospectus for information on obtaining a copy.
TRUSTEES
JEFFREY L. SHAMES,* Chairman and President (born 6/2/55) Massachusetts
Financial Services Company, Chairman and Chief Executive Officer
NELSON J. DARLING, JR. (born 12/27/20)
Private Investor and Trustee
Address: Boston, Massachusetts
WILLIAM R. GUTOW (born 9/27/41)
Private Investor and Real Estate Consultant; Capitol Entertainment
Management Company (video franchise), Vice Chairman
Address: Dallas, Texas
OFFICERS
JAMES O. YOST,* Treasurer (born 6/12/60)
Massachusetts Financial Services Company, Senior Vice
President
STEPHEN E. CAVAN,* Secretary and Clerk (born 11/6/53)
Massachusetts Financial Services Company, Senior Vice President, General
Counsel and Secretary
JAMES R. BORDEWICK, JR.,* Assistant Secretary and Assistant Clerk (born
3/6/59)
Massachusetts Financial Services Company, Senior Vice President and
Associate General Counsel
ELLEN MOYNIHAN,* Assistant Treasurer (born 11/13/57)
Massachusetts Financial Services Company, Vice President (since September
1996); Deloitte & Touche LLP, Senior Manager (until September 1996)
MARK E. BRADLEY,* Assistant Treasurer (born 11/23/59)
Massachusetts Financial Services Company, Vice President (since March
1997); Putnam Investments, Vice President (Prior to March 1997)
LAURA F. HEALY,* Assistant Treasurer (born 3/20/64)
Massachusetts Financial Services Company, Vice President (since December
1996); State Street Bank Fund Administration Group, Assistant Vice
President (prior to December 1996)
----------------
* "Interested persons" (as defined in the 1940 Act) of the Adviser, whose
address is 500 Boylston Street, Boston, Massachusetts 02116.
Each Trustee and officer holds comparable positions with certain affiliates
of MFS or with certain other Funds of which MFS or a subsidiary is the
Investment Adviser or distributor. Messrs. Shames and Scott, Directors of
MFD, and Mr. Cavan, the Secretary of MFD, hold similar positions with
certain other MFS affiliates.
OWNERSHIP BY TRUSTEES AND OFFICERS
Not applicable
25% OR GREATER OWNERSHIP
The following table identifies those investors who own 25% or more of a
Fund's shares, and are therefore presumed to control that Fund:
APPROXIMATE
NUMBER APPROXIMATE %
NAME AND ADDRESS OF SHARES OF OUTSTANDING
FUND OF SHAREHOLDER OWNED SHARES OWNED
--------------------------------------------------------------------------
Not applicable
5% OR GREATER OWNERSHIP The following table identifies those investors who
own 5% or more (but less than 25%) of a Fund's shares:
APPROXIMATE
NUMBER APPROXIMATE %
NAME AND ADDRESS OF SHARES OF OUTSTANDING
FUND OF SHAREHOLDER OWNED SHARES OWNED
--------------------------------------------------------------------------
Not applicable
Each Fund pays the compensation of non-interested Trustees and of Trustees
who are not officers of the Trust, who currently receive an annual fee plus
a fee per meeting and a fee per committee meeting attended, together with
such Trustee's out-of-pocket expenses. The compensation arrangements are as
follows:
PER COMMITTEE
ANNUAL MEETING MEETING
FUND FEE TIME FEE
--------------------------------------------------------------------------
Large Cap Value Fund* N/A N/A N/A
International Research Fund* N/A N/A N/A
REIT Fund 250 70 70
--------------------------------------------------------------------------
*Funds have not yet commenced operations
TRUSTEE COMPENSATION TABLE
..........................................................................
TRUSTEE FEES FROM EACH OF TOTAL TRUSTEE FEES FROM
TRUSTEE THE FUNDS(1) TRUST AND FUND COMPLEX(2)
-------------------------------------------------------------------------
Jeffrey L. Shames $ 0 $ 0
Nelson J. Darling, Jr. 0 54,625
William R. Gutow 0 109,625
----------------
(1) These fees are estimated for each Fund's current fiscal year. The
Trustees are currently waiving their right to receive fees.
(2) Information provided is provided for calendar year 1999. Mr. Darling
served as Trustee of 27 Funds within the MFS Fund complex (having
aggregate net assets at December 31, 1999, of approximately $5.1
billion) and Mr. Gutow served as Trustee of 61 Funds within the MFS
complex (having aggregate net assets at December 31, 1999 of
approximately $20.5 billion).
The Declaration of Trust of the Trust provides that the Trust will
indemnify its Trustees and officers against liabilities and expenses
incurred in connection with litigation in which they may be involved
because of their offices with the Trust, unless, as to liabilities of the
Trust or its shareholders, it is determined that they engaged in willful
misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in their offices, or with respect to any matter, unless it
is adjudicated that they did not act in good faith in the reasonable belief
that their actions were in the best interest of the Trust. In the case of
settlement, such indemnification will not be provided unless it has been
determined pursuant to the Declaration of Trust, that they have not engaged
in willful misfeasance, bad faith, gross negligence or reckless disregard
of their duties.
INVESTMENT ADVISER
The Trust has retained Massachusetts Financial Services Company ("MFS" or
the "Adviser") as each Fund's investment adviser. MFS and its predecessor
organizations have a history of money management dating from 1924. MFS is a
subsidiary of Sun Life of Canada (U.S.) Financial Services Holdings, Inc.,
which in turn is an indirect wholly owned subsidiary of Sun Life Assurance
Company of Canada (an insurance company).
INVESTMENT ADVISORY AGREEMENT -- The Adviser manages each Fund pursuant to
an Investment Advisory Agreement (the "Advisory Agreement"). Under the
Advisory Agreement, the Adviser provides each Fund with overall investment
advisory services. Subject to such policies as the Trustees may determine,
the Adviser makes investment decisions for each Fund. For these services
and facilities, the Adviser receives an annual management fee, computed and
paid monthly, as disclosed in the Prospectus under the heading "Management
of the Funds."
The Adviser pays the compensation of the Trust's officers and of any
Trustee who is an officer of the Adviser. The Adviser also furnishes at its
own expense all necessary administrative services, including office space,
equipment, clerical personnel, investment advisory facilities, and all
executive and supervisory personnel necessary for managing the Fund's
investments and effecting its portfolio transactions.
The Advisory Agreement has an initial two year term and continues in
effect thereafter only if such continuance is specifically approved at
least annually by the Board of Trustees or by vote of a majority of the
Fund's shares (as defined in "Investment Restrictions" of this SAI) and, in
either case, by a majority of the Trustees who are not parties to the
Advisory Agreement or interested persons of any such party. The Advisory
Agreement terminates automatically if it is assigned and may be terminated
without penalty by vote of a majority of the Fund's shares (as defined in
"Investment Restrictions" of this SAI), or by either party on not more than
60 days' nor less than 30 days' written notice. The Advisory Agreement
provides that if MFS ceases to serve as the Adviser to the Fund, the Fund
will change its name so as to delete the initials "MFS" and that MFS may
render services to others and may permit other fund clients to use the
initials "MFS" in their names. The Advisory Agreement also provides that
neither the Adviser nor its personnel shall be liable for any error of
judgment or mistake of law or for any loss arising out of any investment or
for any act or omission in the execution and management of the Fund, except
for willful misfeasance, bad faith or gross negligence in the performance
of its or their duties or by reason of reckless disregard of its or their
obligations and duties under the Advisory Agreement.
INVESTMENT SUB-ADVISER MFS has engaged Sun Capital Advisers, Inc. (referred
to as Sun Capital or the Sub-Adviser) for the Real Estate Investment Fund.
Sun Capital is located at One Sun Life Executive Park, Wellesley Hills,
Massachusetts 02481. Sun Capital is an indirect wholly-owned subsidiary of
Sun Life Assurance Company of Canada (Sun Life of Canada). Sun Life of
Canada and its affiliates currently transact business in Canada, the United
States, the United Kingdom, Asia Pacific and South America. Sun Life of
Canada is a wholly-owned subsidiary of Sun Life Financial Services of
Canada Inc. ("Sun Life Financial"), a corporation organized in Canada, Sun
Life Financial is a reporting company under the Securities Exchange Act of
1934 with common shares listed on the Toronto, New York, London, and Manila
stock exchanges.
The Sub-Adviser is a Delaware corporation and a registered investment
adviser. The Sub-Adviser provides investment management and supervisory
services to mutual funds and pension and profit-sharing accounts.
SUB-ADVISORY AGREEMENT Sun Capital serves as the REIT Fund's Sub-Adviser
pursuant to a Sub-Investment Advisory Agreement between the Adviser and Sun
Capital (the "Sub-Advisory Agreement"). The Sub-Advisory Agreement provides
that the Adviser may delegate to Sun Capital the authority to make
investment decisions for the REIT Fund. It is presently intended that Sun
Capital will provide portfolio management services for the REIT Fund. For
these services, the Adviser pays the Sub-Adviser an investment advisory
fee, computed daily and paid monthly in arrears, at the annual rate of
0.35% of the REIT Fund's average daily net assets. The Sub-Advisory
Agreement will continue in effect provided that such continuance is
specifically approved at least annually by the Board of Trustees or by the
vote of a majority of the REIT Fund's outstanding shares, and, in either
case, by a majority of the Trustees who are not parties to the Sub-Advisory
Agreement or interested persons of any such party. The Sub-Advisory
Agreement terminates automatically if it is assigned and may be terminated
without penalty by the Trustees, by vote of a majority of the REIT Fund's
outstanding shares, or by the Adviser or Sub-Adviser on not less than 30
days' nor more than 60 days' written notice. The Sub-Advisory Agreement
specifically provides that neither the Sub-Adviser nor its personnel shall
be liable for any error of judgment or mistake of law or for any loss
arising out of any investment or for any act or omission in the execution
and management of the REIT Fund, except for willful misfeasance, bad faith
or gross negligence in the performance of its duties or by reason of
reckless disregard of its obligations and duties under the Sub-Advisory
Agreement.
AFFILIATED SERVICE PROVIDER COMPENSATION
The Fund paid compensation to its affiliated service providers over the
specified periods as follows:
NET AMOUNT
PAID TO MFS AMOUNT
FOR ADVISORY WAIVED
FISCAL YEAR ENDED SERVICES BY MFS
--------------------------------------------------------------------------
Not applicable
The Trust pays the compensation of the Trustees who are not officers of
MFS and all expenses of the Fund (other than those assumed by MFS)
including but not limited to: advisory and administrative services;
governmental fees; interest charges; taxes; membership dues in the
Investment Company Institute allocable to the Fund; fees and expenses of
independent auditors, of legal counsel, and of any transfer agent,
registrar or dividend disbursing agent of the Fund; expenses of
repurchasing and redeeming shares and servicing shareholder accounts;
expenses of preparing, printing and mailing prospectuses, periodic reports,
notices and proxy statements to shareholders and to governmental officers
and commissions; brokerage and other expenses connected with the execution,
recording and settlement of portfolio security transactions; insurance
premiums; fees and expenses of State Street Bank and Trust Company, the
Fund's custodian, for all services to the Fund, including safekeeping of
funds and securities and maintaining required books and accounts; expenses
of calculating the net asset value of shares of the Fund; and expenses of
shareholder meetings. Expenses relating to the issuance, registration and
qualification of shares of the Fund and the preparation, printing and
mailing of prospectuses are borne by the Fund except that the Distribution
Agreement with MFD requires MFD to pay for prospectuses that are to be used
for sales purposes. Expenses of the Trust which are not attributable to a
specific series are allocated between the series in a manner believed by
management of the Trust to be fair and equitable.
ADMINISTRATOR
MFS provides each Fund with certain financial, legal, compliance,
shareholder communications and other administrative services pursuant to a
Master Administrative Services Agreement. Under this Agreement, the Fund
pays MFS an administrative fee of up to 0.0175% on the first $2.0 billion;
0.0130% on the next $2.5 billion; 0.0005% on the next $2.5 billion; and
0.0% on amounts in excess of $7.0 billion per annum of a Fund's average
daily net assets. This fee reimburses MFS for a portion of the costs it
incurs to provide such services.
NET AMOUNT
PAID TO MFS FOR
ADMINISTRATIVE
FISCAL YEAR ENDED SERVICES
--------------------------------------------------------------------------
Not applicable
CUSTODIAN
State Street Bank and Trust Company (the "Custodian") is the custodian of
each Fund's assets. The Custodian's responsibilities include safekeeping
and controlling the Fund's cash and securities, handling the receipt and
delivery of securities, determining income and collecting interest and
dividends on the Fund's investments, maintaining books of original entry
for portfolio and fund accounting and other required books and accounts,
and calculating the daily net asset value of the Fund. The Custodian does
not determine the investment policies of the Fund or decide which
securities the Fund will buy or sell. The Fund may, however, invest in
securities of the Custodian and may deal with the Custodian as principal in
securities transactions. The Custodian also acts as the dividend disbursing
agent of the Fund.
SHAREHOLDER SERVICING AGENT
MFS Service Center, Inc. ("MFSC"), a wholly owned subsidiary of MFS, is
each Fund's shareholder servicing agent, pursuant to an Amended and
Restated Shareholder Servicing Agreement (the "Agency Agreement"). The
Shareholder Servicing Agent's responsibilities under the Agency Agreement
include administering and performing transfer agent functions and the
keeping of records in connection with the issuance, transfer and redemption
of shares of the Funds. For these services, MFSC will receive a fee
calculated as a percentage of the average daily net assets of each Fund at
an effective annual rate of up to 0.0075%. In addition, MFSC will be
reimbursed by each Fund for certain expenses incurred by MFSC on behalf of
the Fund. The Custodian has contracted with MFSC to perform certain
dividend disbursing agent functions for each Fund.
NET AMOUNT
PAID TO MFSC
FOR TRANSFER
AGENCY
FISCAL YEAR ENDED SERVICES
--------------------------------------------------------------------------
Not applicable
DISTRIBUTOR
MFS Fund Distributors, Inc. ("MFD"), a wholly owned subsidiary of MFS,
serves as distributor for the continuous offering of shares of the Fund
pursuant to an Amended and Restated Distribution Agreement (the
"Distribution Agreement"). The Distribution Agreement has an initial two
year term and continues in effect thereafter only if such continuance is
specifically approved at least annually by the Board of Trustees or by vote
of a majority of the Fund's shares (as defined in "Investment Restrictions"
of this SAI) and in either case, by a majority of the Trustees who are not
parties to the Distribution Agreement or interested persons of any such
party. The Distribution Agreement terminates automatically if it is
assigned and may be terminated without penalty by either party on not more
than 60 days' nor less than 30 days' notice.
V PORTFOLIO TRANSACTIONS AND BROKERAGE COMMISSIONS
Specific decisions to purchase or sell securities for the Funds are made by
persons affiliated with the Adviser or the Sub-Adviser. Any such person may
serve other clients of the Adviser or the Sub-Adviser, or any subsidiary of
the Adviser or Sub-Adviser in a similar capacity. Changes in a Fund's
investments are reviewed by the Trust's Board of Trustees.
The primary consideration in placing portfolio security transactions is
execution at the most favorable prices. The Adviser and the Sub-Adviser
have complete freedom as to the markets in and broker-dealers through which
they seek this result. In the U.S. and in some other countries debt
securities are traded principally in the over-the-counter market on a net
basis through dealers acting for their own account and not as brokers. In
other countries both debt and equity securities are traded on exchanges at
fixed commission rates. The cost of securities purchased from underwriters
includes an underwriter's commission or concession, and the prices at which
securities are purchased and sold from and to dealers include a dealer's
mark-up or mark-down. The Adviser and Sub-Adviser normally seek to deal
directly with the primary market makers or on major exchanges unless, in
their opinion, better prices are available elsewhere. Subject to the
requirement of seeking execution at the best available price, securities
may, as authorized by the Advisory Agreement and the Sub-Advisory
Agreement, be bought from or sold to dealers who have furnished
statistical, research and other information or services to the Adviser or
the Sub-Adviser. At present no arrangements for the recapture of commission
payments are in effect.
Consistent with the foregoing primary consideration, the Conduct Rules of
the National Association of Securities Dealers, Inc. ("NASD") and such
other policies as the Trustees may determine, the Adviser may consider
sales of shares of the Funds and of the other investment company clients of
MFD as a factor in the selection of broker-dealers to execute the Funds'
portfolio transactions.
Under the Advisory Agreement and the Sub-Advisory Agreement and as
permitted by Section 28(e) of the Securities Exchange Act of 1934, the
Adviser and the Sub-Adviser may cause a Fund to pay a broker-dealer which
provides brokerage and research services to the Adviser or the Sub-Adviser,
an amount of commission for effecting a securities transaction for a Fund
in excess of the amount other broker-dealers would have charged for the
transaction, if the Adviser or the Sub-Adviser determines in good faith
that the greater commission is reasonable in relation to the value of the
brokerage and research services provided by the executing broker-dealer
viewed in terms of either a particular transaction or their respective
overall responsibilities to the Fund or to their other clients. Not all of
such services are useful or of value in advising a Fund.
The term "brokerage and research services" includes advice as to the
value of securities, the advisability of investing in, purchasing or
selling securities, and the availability of securities or of purchasers or
sellers of securities; furnishing analyses and reports concerning issues,
industries, securities, economic factors and trends, portfolio strategy and
the performance of accounts; and effecting securities transactions and
performing functions incidental thereto, such as clearance and settlement.
Although commissions paid on every transaction will, in the judgment of
the Adviser or Sub-Adviser, be reasonable in relation to the value of the
brokerage services provided, commissions exceeding those which another
broker might charge may be paid to broker-dealers who were selected to
execute transactions on behalf of a Fund and the Adviser's or Sub-Adviser's
other clients in part for providing advice as to the availability of
securities or of purchasers or sellers of securities and services in
effecting securities transactions and performing functions incidental
thereto, such as clearance and settlement.
Broker-dealers may be willing to furnish statistical, research and other
factual information or services ("Research") to the Adviser or Sub-Adviser
for no consideration other than brokerage or underwriting commissions.
Securities may be bought or sold from time to time through such
broker-dealers, on behalf of a Fund. The Trustees (together with the
Trustees of certain other MFS Funds) have directed the Adviser to allocate
a total of $43,800 of commission business from certain MFS Funds (including
the Funds) to the Pershing Division of Donaldson Lufkin & Jenrette as
consideration for the annual renewal of certain publications provided by
Lipper Analytical Securities Corporation (which provides information useful
to the Trustees in reviewing the relationship between the Funds and the
Adviser).
The Adviser's and Sub-Adviser's investment management personnel attempt
to evaluate the quality of Research provided by brokers. The Adviser and
Sub-Adviser sometimes use evaluations resulting from this effort as a
consideration in the selection of brokers to execute portfolio
transactions.
The management fee of the Adviser and Sub-Adviser will not be reduced as
a consequence of the Adviser's or Sub-Adviser's receipt of brokerage and
research service. To the extent a Fund's portfolio transactions are used to
obtain brokerage and research services, the brokerage commissions paid by
the Fund will exceed those that might otherwise be paid for such portfolio
transactions, or for such portfolio transactions and research, by an amount
which cannot be presently determined. Such services would be useful and of
value to the Adviser or Sub-Adviser in serving both the Fund and other
clients and, conversely, such services obtained by the placement of
brokerage business of other clients would be useful to the Adviser or
Sub-Adviser in carrying out its obligations to a Fund. While such services
are not expected to reduce the expenses of the Adviser or Sub-Adviser, the
Adviser or Sub-Adviser would, through use of the services, avoid the
additional expenses which would be incurred if it should attempt to develop
comparable information through its own staff.
In certain instances there may be securities which are suitable for a
Fund's portfolio as well as for that of one or more of the other clients of
the Adviser or Sub-Adviser or any subsidiary of the Adviser or Sub-Adviser.
Investment decisions for a Fund and for such other clients are made with a
view to achieving their respective investment objectives. It may develop
that a particular security is bought or sold for only one client even
though it might be held by, or bought or sold for, other clients. Likewise,
a particular security may be bought for one or more clients when one or
more other clients are selling that same security. Some simultaneous
transactions are inevitable when several clients receive investment advice
from the same investment adviser, particularly when the same security is
suitable for the investment objectives of more than one client. When two or
more clients are simultaneously engaged in the purchase or sale of the same
security, the securities are allocated among clients in a manner believed
by the adviser to be equitable to each. It is recognized that in some cases
this system could have a detrimental effect on the price or volume of the
security as far as a Fund is concerned. In other cases, however, a Fund
believes that its ability to participate in volume transactions will
produce better executions for a Fund.
Brokerage commissions paid by each Fund for certain specified periods,
and information concerning purchases by the Funds of securities issued by
their regular broker-dealers for the Funds' most recent fiscal year, is set
forth below.
BROKERAGE COMMISSIONS
..........................................................................
The Funds are newly organized and no brokerage commissions were paid by the
Funds as of the date of this SAI.
BROKERAGE
COMMISSIONS
FUND PAID BY FUND
-------------------------------------------------------------------------
Not applicable
SECURITIES ISSUED BY REGULAR BROKER-DEALERS
..........................................................................
The Funds are newly organized and have not purchased securities issued by
regular broker-dealers as of the date of this SAI.
FUND/BROKER-DEALER VALUE OF SECURITIES
----------------------------------------------------------------------
Not applicable
VI TAX CONSIDERATIONS
The following discussion is a brief summary of some of the important
federal (and, where noted, state and local) income tax consequences
affecting each Fund and its shareholders. The discussion is very general,
and therefore prospective investors are urged to consult their tax advisors
about the impact an investment in the Funds may have on their own tax
situations.
TAXATION OF THE FUNDS
FEDERAL TAXES -- Each Fund is treated as a separate corporation for federal
tax purposes under the Internal Revenue Code of 1986, as amended (the
"Code"). Each Fund intends to elect to be, and intends to qualify to be
treated each year as, a "regulated investment company" under Subchapter M
of the Code by meeting all applicable requirements of Subchapter M,
including requirements as to the nature of the Fund's gross income, the
amount of its distributions (as a percentage of its overall income), and
the composition of its portfolio assets. As a regulated investment company,
a Fund will not be subject to any federal income or excise taxes on its net
investment income and net realized capital gains that it distributes to its
shareholders in accordance with the timing requirements imposed by the
Code. A Fund's foreign-source income, if any, may be subject to foreign
withholding taxes. If any Fund failed to qualify for treatment as a
"regulated investment company" for any taxable year, it would incur federal
corporate income tax on all of its taxable income for that year, whether or
not distributed, and Fund distributions would generally be taxable as
ordinary dividend income to its shareholders.
MASSACHUSETTS TAXES -- As long as it qualifies as a regulated investment
company under the Code, a Fund will not be required to pay Massachusetts
income or excise taxes.
TAXATION OF SHAREHOLDERS
TAX TREATMENT OF DISTRIBUTIONS -- Shareholders of a Fund that are not
tax-exempt entities normally will have to pay federal income tax and any
state or local income taxes on the dividends and capital gain distributions
they receive from the Fund. Any dividends from ordinary income and net
short-term capital gains are taxable to shareholders as ordinary income for
federal income tax purposes, whether paid in cash or reinvested in
additional shares. Distributions of net capital gain (i.e., the excess of
net long-term capital gain over net short-term capital loss), whether paid
in cash or reinvested in additional shares, are taxable to shareholders as
long-term capital gains for federal income tax purposes without regard to
the length of time they have held their shares. Any Fund dividend or other
distribution that is declared in October, November, or December of any
calendar year, payable to shareholders of record in such a month, and paid
during the following January will be treated as if received by the
shareholders on December 31 of the year in which the distribution is
declared. Each Fund will notify its shareholders regarding the federal tax
status of its distributions after the end of each calendar year.
DIVIDENDS-RECEIVED DEDUCTION -- If a Fund receives dividend income from
U.S. corporations, a portion of its income dividends is normally eligible
for the dividends-received deduction for a corporate shareholder that
otherwise qualifies for that deduction with respect to its holding of Fund
shares. Availability of the deduction for particular corporate shareholders
is subject to certain limitations, and deducted amounts may be subject to
the federal alternative minimum tax or result in certain basis adjustments.
DISPOSITION OF SHARES -- In general, any gain or loss a shareholder
realizes upon a disposition of Fund shares by a shareholder that holds such
shares as a capital asset will be treated as a long-term capital gain or
loss if the shares have been held for more than twelve months and otherwise
as a short-term capital gain or loss. However, any loss realized upon a
disposition of Fund shares held for six months or less will be treated as a
long-term capital loss to the extent of any distributions of net capital
gain made with respect to those shares. Any loss realized on a disposition
of shares may also be disallowed under rules relating to "wash sales." Gain
may be increased (or loss reduced) on a redemption of Class A Fund shares
held for 90 days or less followed by any purchase (including purchases by
exchange or by reinvestment) without payment of an additional sales charge
of Class A shares of the Fund or of any other shares of an MFS Fund
generally sold subject to a sales charge.
DISTRIBUTION/ACCOUNTING POLICIES -- A Fund's current distribution and
accounting policies will affect the amount, timing, and character of
distributions to shareholders and may, under certain circumstances, make an
economic return of capital taxable to shareholders.
FOREIGN INCOME TAXATION OF NON-U.S. PERSONS -- Distributions received from
a Fund by persons who are not citizens or residents of the United States or
U.S. entities may also be subject to tax under the laws of their own
jurisdictions.
STATE AND LOCAL INCOME TAXES: U.S. GOVERNMENT SECURITIES -- Dividends paid
by a Fund that are derived from interest on obligations of the U.S.
Government and certain of its agencies and instrumentalities (but generally
not distributions of capital gains realized upon the disposition of those
obligations) may be exempt from state and local personal income taxes. Each
Fund generally intends to advise shareholders of the extent, if any, to
which its dividends consist of such interest. Shareholders are urged to
consult their tax advisors regarding the possible exclusion of such portion
of their dividends for state and local income tax purposes.
CERTAIN SPECIFIC INVESTMENTS -- Any investment in zero coupon bonds,
deferred interest bonds, payment-in-kind bonds, certain stripped
securities, and certain securities purchased at a market discount will
cause a Fund to recognize income prior to the receipt of cash payments with
respect to those securities. To distribute this income (as well as non-cash
income described in the next two paragraphs) and avoid a tax on a Fund, it
may be required to liquidate portfolio securities that it might otherwise
have continued to hold, potentially resulting in additional taxable gain or
loss to the Fund. Any investment in residual interests of a CMO that has
elected to be treated as a real estate mortgage investment conduit, or
"REMIC," can create complex tax problems, especially for a Fund that has
state or local governments or other tax-exempt organizations as
shareholders.
OPTIONS, FUTURES CONTRACTS, AND FORWARD CONTRACTS -- Any Fund's
transactions in options, Futures Contracts, Forward Contracts, short sales
"against the box," and swaps and related transactions will be subject to
special tax rules that may affect the amount, timing, and character of Fund
income and distributions to shareholders. For example, certain positions
held by a Fund on the last business day of each taxable year will be marked
to market (i.e., treated as if closed out) on that day, and any gain or
loss associated with the positions will be treated as 60% long-term and 40%
short-term capital gain or loss. Certain positions held by a Fund that
substantially diminish its risk of loss with respect to other positions in
its portfolio may constitute "straddles" and may be subject to special tax
rules that would cause deferral of Fund losses, adjustments in the holding
periods of Fund securities, and conversion of short-term into long-term
capital losses. Certain tax elections exist for straddles that may alter
the effects of these rules. Each Fund will limit its activities in options,
Futures Contracts, Forward Contracts, short sales "against the box," and
swaps and related transactions to the extent necessary to meet the
requirements of Subchapter M of the Code.
If a Fund enters into a "constructive sale" of "certain appreciated
financial positions," the Fund will generally recognize gain at that time,
even through the Fund has not actually sold the position. A constructive
sale generally consists of a short sale against the box, an offsetting
notional principal contract, or a Futures or Forward Contract entered into
by a Fund or a related person with respect to the same or substantially
identical property.
FOREIGN INVESTMENTS -- Special tax considerations apply with respect to
foreign investments by a Fund. Foreign exchange gains and losses realized
by a Fund may be treated as ordinary income and loss. Use of foreign
currencies for non-hedging purposes and investment by a Fund in certain
"passive foreign investment companies" may be limited in order to avoid a
tax on the Fund. A Fund may elect to mark to market any investments in
"passive foreign investment companies" on the last day of each year. This
election may cause the Fund to recognize income prior to the receipt of
cash payments with respect to those investments; in order to distribute
this income and avoid a tax on the Fund, it may be required to liquidate
portfolio securities that it might otherwise have continued to hold,
potentially resulting in additional taxable gain or loss to the Fund.
FOREIGN INCOME TAXES -- Investment income received by a Fund and gains with
respect to foreign securities realized by a Fund may be subject to foreign
income taxes withheld at the source. The United States has entered into tax
treaties with many foreign countries that may entitle a Fund to a reduced
rate of tax or an exemption from tax on such income; each Fund intends to
qualify for treaty reduced rates where available. It is not possible,
however, to determine any Fund's effective rate of foreign tax in advance,
since the amount of each Fund's assets to be invested within various
countries is not known.
If a Fund holds more than 50% of its assets in stock and securities of
foreign corporations at the close of its taxable year, it may elect to
"pass through" to its shareholders foreign income taxes paid by it. If a
Fund so elects, its shareholders will be required to treat their pro rata
portions of the foreign income taxes paid by the Fund as part of the
amounts distributed to them by it and thus includable in their gross income
for federal income tax purposes. Shareholders who itemize deductions would
then be allowed to claim a deduction or credit (but not both) on their
federal income tax returns for those amounts, subject to certain
limitations. Shareholders who do not itemize deductions would (subject to
those limitations) be able to claim a credit but not a deduction. No
deduction will be permitted to individuals in computing their alternative
minimum tax liability. If a Fund is not eligible, or does not elect, to
"pass through" to its shareholders foreign income taxes it has paid,
shareholders will not be able to claim any deduction or credit for any part
of the foreign taxes paid by the Fund.
VII NET INCOME AND DISTRIBUTIONS
Each Fund intends to distribute to its shareholders dividends equal to all
of its net investment income with the frequency as is disclosed in the
Fund's prospectus. A Fund's net investment income consists of non-capital
gain income less expenses. In addition, the Funds intend to distribute net
realized short- and long-term capital gains, if any, at least annually.
Shareholders will be informed of the tax consequences of those
distributions, including whether any portion thereof represents a return of
capital, after the end of each calendar year.
VIII DETERMINATION OF NET ASSET VALUE
The net asset value per share of each Fund is determined each day during
which the New York Stock Exchange is open for trading. (As of the date of
this SAI, the Exchange is open for trading every weekday except for the
following holidays (or the days on which they are observed): New Year's
Day; Martin Luther King Day; Presidents' Day; Good Friday; Memorial Day;
Independence Day; Labor Day; Thanksgiving Day and Christmas Day.) This
determination is made once each day as of the close of regular trading on
the Exchange by deducting the amount of the liabilities attributable to the
Fund from the value of the assets attributable to the Fund and dividing the
difference by the number of shares of the Fund outstanding.
Equity securities in a Fund's portfolio are valued at the last sale price
on the exchange on which they are primarily traded or on the Nasdaq stock
market system for unlisted national market issues, or at the last quoted
bid price for listed securities in which there were no sales during the day
or for unlisted securities not reported on the Nasdaq stock market system.
Bonds and other fixed income securities (other than short-term obligations)
of U.S. issuers in a Fund's portfolio are valued on the basis of valuations
furnished by a pricing service which utilizes both dealer-supplied
valuations and electronic data processing techniques which take into
account appropriate factors such as institutional-size trading in similar
groups of securities, yield, quality, coupon rate, maturity, type of issue,
trading characteristics and other market data without exclusive reliance
upon quoted prices or exchange or over-the-counter prices, since such
valuations are believed to reflect more accurately the fair value of such
securities. Forward Contracts will be valued using a pricing model taking
into consideration market data from an external pricing source. Use of the
pricing services has been approved by the Board of Trustees.
All other securities, futures contracts and options in a Fund's
portfolio (other than short-term obligations) for which the principal
market is one or more securities or commodities exchanges (whether domestic
or foreign) will be valued at the last reported sale price or at the
settlement price prior to the determination (or if there has been no
current sale, at the closing bid price) on the primary exchange on which
such securities, futures contracts or options are traded; but if a
securities exchange is not the principal market for securities, such
securities will, if market quotations are readily available, be valued at
current bid prices, unless such securities are reported on the Nasdaq stock
market system, in which case they are valued at the last sale price or, if
no sales occurred during the day, at the last quoted bid price. Short-term
obligations in the Fund's portfolio are valued at amortized cost, which
constitutes fair value as determined by the Board of Trustees. Short-term
obligations with a remaining maturity in excess of 60 days will be valued
upon dealer supplied valuations. Portfolio investments for which there are
no such quotations or valuations are valued at fair value as determined in
good faith by or at the direction of the Board of Trustees.
Generally, trading in foreign securities is substantially completed each
day at various times prior to the close of regular trading on the Exchange.
Occasionally, events affecting the values of such securities may occur
between the times at which they are determined and the close of regular
trading on the Exchange which will not be reflected in the computation of
the Fund's net asset value unless the Trustees deem that such event would
materially affect the net asset value in which case an adjustment would be
made.
All investments and assets are expressed in U.S. dollars based upon
current currency exchange rates. A share's net asset value is effective for
orders received by MFD prior to the close of that business day.
IX PERFORMANCE INFORMATION
FUNDS
Each Fund may quote the following performance results.
TOTAL RATE OF RETURN -- Each Fund will calculate its total rate of return
for shares for certain periods by determining the average annual compounded
rates of return over those periods that would cause an investment of $1,000
(made with all distributions reinvested and reflecting the maximum public
offering price) to reach the value of that investment at the end of the
periods. Each Fund may also calculate total rates of return which represent
aggregate performance over a period or year-by-year performance.
Any total rate of return quotation provided by a Fund should not be
considered as representative of the performance of the Fund in the future
since the net asset value of shares of the Fund will vary based not only on
the type, quality and maturities of the securities held in the Fund's
portfolio, but also on changes in the current value of such securities and
on changes in the expenses of the Fund. These factors and possible
differences in the methods used to calculate total rates of return should
be considered when comparing the total rate of return of the Fund to total
rates of return published for other investment companies or other
investment vehicles. Total rate of return reflects the performance of both
principal and income. Total rate of return quotations for each Fund are
presented in Appendix C attached hereto.
YIELD -- Any yield quotation for a Fund is based on the annualized net
investment income per share of a Fund for the 30-day period. The yield for
a Fund is calculated by dividing the net investment income per share of a
Fund earned during the period by the maximum offering price per share of a
Fund on the last day of the period. The resulting figure is then
annualized. Net investment income per share is determined by dividing (i)
the dividends and interest earned by a Fund during the period, minus
accrued expenses for the period by (ii) the average number of Fund shares
entitled to receive dividends during the period multiplied by the maximum
offering price per share on the last day of the period. Yield quotations
for each Fund are presented in Appendix C attached hereto.
CURRENT DISTRIBUTION RATE -- Yield, which is calculated according to a
formula prescribed by the Securities and Exchange Commission, is not
indicative of the amounts which were or will be paid to the Fund's
shareholders. Amounts paid to shareholders of each Fund are reflected in
the quoted "current distribution rate" for that Fund. The current
distribution rate for a Fund is computed by (i) annualizing the
distributions (excluding short-term capital gains) of the Fund for a stated
period; (ii) adding any short-term capital gains paid within the
immediately preceding twelve-month period; and (iii) dividing the result by
the maximum offering price or net asset value per share on the last day of
the period. The current distribution rate differs from the yield
computation because it may include distributions to shareholders from
sources other than dividends and interest, such as premium income for
option writing, short-term capital gains and return of invested capital,
and may be calculated over a different period of time.
GENERAL
From time to time each Fund may, as appropriate, quote Fund rankings or
reprint all or a portion of evaluations of fund performance and operations
appearing in various independent publications, including but not limited to
the following: Money, Fortune, U.S. News and World Report, Kiplinger's
Personal Finance, The Wall Street Journal, Barron's, Investors Business
Daily, Newsweek, Financial World, Financial Planning, Investment Advisor,
USA Today, Pensions and Investments, SmartMoney, Forbes, Global Finance,
Registered Representative, Institutional Investor, the Investment Company
Institute, Johnson's Charts, Morningstar, Lipper Inc., CDA Wiesenberger,
Shearson Lehman and Salomon Bros. Indices, Ibbotson, Business Week, Lowry
Associates, Media General, Investment Company Data, The New York Times,
Your Money, Strangers Investment Advisor, Financial Planning on Wall
Street, Standard and Poor's, Individual Investor, The 100 Best Mutual Funds
You Can Buy, by Gordon K. Williamson, Consumer Price Index, and Sanford C.
Bernstein & Co. Fund performance may also be compared to the performance of
other mutual funds tracked by financial or business publications or
periodicals. The Fund may also quote evaluations mentioned in independent
radio or television broadcasts and use charts and graphs to illustrate the
past performance of various indices such as those mentioned above and
illustrations using hypothetical rates of return to illustrate the effects
of compounding and tax-deferral. The Fund may advertise examples of the
effects of periodic investment plans, including the principle of dollar
cost averaging. In such a program, an investor invests a fixed dollar
amount in a fund at periodic intervals, thereby purchasing fewer shares
when prices are high and more shares when prices are low. While such a
strategy does not assure a profit or guard against a loss in a declining
market, the investor's average cost per share can be lower than if fixed
numbers of shares are purchased at the same intervals.
From time to time, each Fund may discuss or quote its current portfolio
manager as well as other investment personnel, including such persons'
views on: the economy; securities markets; portfolio securities and their
issuers; investment philosophies, strategies, techniques and criteria used
in the selection of securities to be purchased or sold for the Fund; the
Fund's portfolio holdings; the investment research and analysis process;
the formulation and evaluation of investment recommendations; and the
assessment and evaluation of credit, interest rate, market and economic
risks, and similar or related matters.
Each Fund may also use charts, graphs or other presentation formats to
illustrate the historical correlation of its performance to fund categories
established by Morningstar (or other nationally recognized statistical
ratings organizations) and to other MFS Funds.
From time to time each Fund may also discuss or quote the views of its
distributor, its investment adviser or sub-adviser and other financial
planning, legal, tax, accounting, insurance, estate planning and other
professionals, or from surveys, regarding individual and family financial
planning. Such views may include information regarding: retirement
planning; tax management strategies; estate planning; general investment
techniques (e.g., asset allocation and disciplined saving and investing);
business succession; ideas and information provided through the MFS
Heritage Planning(SM) program, an intergenerational financial planning
assistance program; issues with respect to insurance (e.g., disability and
life insurance and Medicare supplemental insurance); issues regarding
financial and health care management for elderly family members; the
history of the mutual fund industry; investor behavior; and other similar
or related matters.
From time to time, each Fund may also advertise annual returns showing
the cumulative value of an initial investment in the Fund in various
amounts over specified periods, with capital gain and dividend
distributions invested in additional shares or taken in cash, and with no
adjustment for any income taxes (if applicable) payable by shareholders.
MFS FIRSTS
MFS has a long history of innovations.
1924 -- Massachusetts Investors Trust is established as the first
open-end mutual fund in America.
1924 -- Massachusetts Investors Trust is the first mutual fund to make
full public disclosure of its operations in shareholder reports.
1932 -- One of the first internal research departments is established to
provide in-house analytical capability for an investment management firm.
1933 -- Massachusetts Investors Trust is the first mutual fund to
register under the Securities Act of 1933 ("Truth in Securities Act" or
"Full Disclosure Act").
1936 -- Massachusetts Investors Trust is the first mutual fund to allow
shareholders to take capital gain distributions either in additional shares
or in cash.
1976 -- MFS(R) Municipal Bond Fund is among the first municipal bond
funds established.
1979 -- Spectrum becomes the first combination fixed/ variable annuity
with no initial sales charge.
1981 -- MFS(R) Global Governments Fund is established as America's first
globally diversified fixed-income mutual fund.
1984 -- MFS(R) Municipal High Income Fund is the first open-end mutual
fund to seek high tax-free income from lower-rated municipal securities.
1986 -- MFS(R) Managed Sectors Fund becomes the first mutual fund to
target and shift investments among industry sectors for shareholders.
1986 -- MFS(R) Municipal Income Trust is the first closed-end, high-yield
municipal bond fund traded on the New York Stock Exchange.
1987 -- MFS(R) Multimarket Income Trust is the first closed-end,
multimarket high income fund listed on the New York Stock Exchange.
1989 -- MFS(R) Regatta becomes America's first non-qualified market value
adjusted fixed/variable annuity.
1990 -- MFS(R) Global Total Return Fund is the first global balanced
fund.
1993 -- MFS(R) Global Growth Fund is the first global emerging markets
fund to offer the expertise of two sub-advisers.
1993 -- MFS becomes money manager of MFS(R) Union Standard(R) Equity
Fund, the first fund to invest principally in companies deemed to be
union-friendly by an advisory board of senior labor officials, senior
managers of companies with significant labor contracts, academics and other
national labor leaders or experts. Performance information, as quoted by
the Funds in sales literature and marketing materials, is set forth below.
X DESCRIPTION OF SHARES, VOTING RIGHTS AND LIABILITIES
The Declaration of Trust permits the Trustees to issue an unlimited
number of full and fractional Shares of Beneficial Interest (without par
value) of one or more separate series and to divide or combine the shares
of any series into a greater or lesser number of shares without thereby
changing the proportionate beneficial interests in that series. Upon
liquidation of the Fund, shareholders of each Fund are entitled to share
pro rata in the Fund's net assets available for distribution to
shareholders. The Trust reserves the right to create and issue a number of
series and additional shares, in which case the shares of a series would
participate equally in the earnings, dividends and assets allocable to that
particular series.
Shareholders are entitled to one vote for each share held and may vote in
the election of Trustees and on other matters submitted to meetings of
shareholders. To the extent a shareholder of the Fund owns a controlling
percentage of the Fund's shares, such shareholder may affect the outcome of
such matters to a greater extent than other Fund shareholders. Although
Trustees are not elected annually by the shareholders, the Declaration of
Trust provides that a Trustee may be removed from office at a meeting of
shareholders by a vote of two-thirds of the outstanding shares of the
Trust. A meeting of shareholders will be called upon the request of
shareholders of record holding in the aggregate not less than 10% of the
outstanding voting securities of the Trust. No material amendment may be
made to the Declaration of Trust without the affirmative vote of a majority
of the Trust's outstanding shares (as defined in "Investment Restrictions"
of this SAI). The Trust or any series of the Trust may be terminated (i)
upon the merger or consolidation of the Trust or any series of the Trust
with another organization or upon the sale of all or substantially all of
its assets (or all or substantially all of the assets belonging to any
series of the Trust), if approved by the vote of the holders of two-thirds
of the Trust's or the affected series' outstanding shares voting as a
single class, or of the affected series of the Trust, except that if the
Trustees recommend such merger, consolidation or sale, the approval by vote
of the holders of a majority of the Trust's or the affected series'
outstanding shares will be sufficient, or (ii) upon liquidation and
distribution of the assets of a Fund, if approved by the vote of the
holders of two-thirds of its outstanding shares of the Trust, or (iii) by
the Trustees by written notice to its shareholders. If not so terminated,
the Trust will continue indefinitely.
The Trust is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of such a trust may,
under certain circumstances, be held personally liable as partners for its
obligations. However, the Declaration of Trust contains an express
disclaimer of shareholder liability for acts or obligations of the Trust
and provides for indemnification and reimbursement of expenses out of Trust
property for any shareholder held personally liable for the obligations of
the Trust. The Declaration of Trust also provides that the Trust shall
maintain appropriate insurance (for example, fidelity bonding and errors
and omissions insurance) for the protection of the Trust and its
shareholders and the Trustees, officers, employees and agents of the Trust
covering possible tort and other liabilities. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which both inadequate insurance existed and the
Trust itself was unable to meet its obligations.
The Declaration of Trust further provides that obligations of the Trust
are not binding upon the Trustees individually but only upon the property
of the Trust and that the Trustees will not be liable for any action or
failure to act, but nothing in the Declaration of Trust protects a Trustee
against any liability to which he would otherwise be subject by reason of
his willful misfeasance, bad faith, gross negligence, or reckless disregard
of the duties involved in the conduct of his office.
XI INDEPENDENT AUDITORS AND FINANCIAL STATEMENTS
Deloitte & Touche LLP are the Funds' independent auditors, providing audit
services, tax services, and assistance and consultation with respect to the
preparation of filings with the Securities and Exchange Commission.
<PAGE>
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APPENDIX A
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INVESTMENT TECHNIQUES, PRACTICES AND RISKS
Set forth below is a description of investment techniques and practices
which a Fund may generally use in pursuing its investment objectives and
principal investment policies, and the risks associated with these
investment techniques and practices. Each Fund will engage only in certain
of these investment techniques and practices, as identified in Appendix A of
the Prospectus. Investment practices and techniques that are not identified
in Appendix A of the Prospectus do not apply to a Fund.
INVESTMENT TECHNIQUES AND PRACTICES
DEBT SECURITIES
To the extent a Fund invests in the following types of debt securities, its
net asset value may change as the general levels of interest rates
fluctuate. When interest rates decline, the value of debt securities can be
expected to rise. Conversely, when interest rates rise, the value of debt
securities can be expected to decline. A Fund's investment in debt
securities with longer terms to maturity are subject to greater volatility
than a Fund's shorter-term obligations. Debt securities may have all types
of interest rate payment and reset terms, including fixed rate, adjustable
rate, zero coupon, contingent, deferred, payment in kind and auction rate
features.
ASSET-BACKED SECURITIES: A Fund may purchase the following types of
asset-backed securities:
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTICLASS PASS-THROUGH
SECURITIES: A Fund may invest a portion of its assets in collateralized
mortgage obligations or "CMOs," which are debt obligations collateralized by
mortgage loans or mortgage pass-through securities (such collateral referred
to collectively as "Mortgage Assets"). Unless the context indicates
otherwise, all references herein to CMOs include multiclass pass-through
securities.
Interest is paid or accrues on all classes of the CMOs on a monthly,
quarterly or semi-annual basis. The principal of and interest on the
Mortgage Assets may be allocated among the several classes of a CMO in
innumerable ways. In a common structure, payments of principal, including
any principal prepayments, on the Mortgage Assets are applied to the classes
of a CMO in the order of their respective stated maturities or final
distribution dates, so that no payment of principal will be made on any
class of CMOs until all other classes having an earlier stated maturity or
final distribution date have been paid in full. Certain CMOs may be stripped
(securities which provide only the principal or interest factor of the
underlying security). See "Stripped Mortgage-Backed Securities" below for a
discussion of the risks of investing in these stripped securities and of
investing in classes consisting of interest payments or principal payments.
A Fund may also invest in parallel pay CMOs and Planned Amortization Class
CMOs ("PAC Bonds"). Parallel pay CMOs are structured to provide payments of
principal on each payment date to more than one class. These simultaneous
payments are taken into account in calculating the stated maturity date or
final distribution date of each class, which, as with other CMO structures,
must be retired by its stated maturity date or final distribution date but
may be retired earlier.
CORPORATE ASSET-BACKED SECURITIES: A Fund may invest in corporate
asset-backed securities. These securities, issued by trusts and special
purpose corporations, are backed by a pool of assets, such as credit card
and automobile loan receivables, representing the obligations of a number of
different parties. These securities present certain risks. For instance, in
the case of credit card receivables, these securities may not have the
benefit of any security interest in the related collateral. Credit card
receivables are generally unsecured and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, many of
which give such debtors the right to set off certain amounts owed on the
credit cards, thereby reducing the balance due. Most issuers of automobile
receivables permit the servicers to retain possession of the underlying
obligations. If the servicer were to sell these obligations to another
party, there is a risk that the purchaser would acquire an interest superior
to that of the holders of the related automobile receivables. In addition,
because of the large number of vehicles involved in a typical issuance and
technical requirements under state laws, the trustee for the holders of the
automobile receivables may not have a proper security interest in all of the
obligations backing such receivables. Therefore, there is the possibility
that recoveries on repossessed collateral may not, in some cases, be
available to support payments on these securities. The underlying assets
(e.g., loans) are also subject to prepayments which shorten the securities'
weighted average life and may lower their return.
Corporate asset-backed securities are backed by a pool of assets
representing the obligations of a number of different parties. To lessen the
effect of failures by obligors on underlying assets to make payments, the
securities may contain elements of credit support which fall into two
categories: (i) liquidity protection and (ii) protection against losses
resulting from ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances, generally by the
entity administering the pool of assets, to ensure that the receipt of
payments on the underlying pool occurs in a timely fashion. Protection
against losses resulting from ultimate default ensures payment through
insurance policies or letters of credit obtained by the issuer or sponsor
from third parties. A Fund will not pay any additional or separate fees for
credit support. The degree of credit support provided for each issue is
generally based on historical information respecting the level of credit
risk associated with the underlying assets. Delinquency or loss in excess of
that anticipated or failure of the credit support could adversely affect the
return on an investment in such a security.
MORTGAGE PASS-THROUGH SECURITIES: A Fund may invest in mortgage
pass-through securities. Mortgage pass-through securities are securities
representing interests in "pools" of mortgage loans. Monthly payments of
interest and principal by the individual borrowers on mortgages are passed
through to the holders of the securities (net of fees paid to the issuer or
guarantor of the securities) as the mortgages in the underlying mortgage
pools are paid off. The average lives of mortgage pass-throughs are variable
when issued because their average lives depend on prepayment rates. The
average life of these securities is likely to be substantially shorter than
their stated final maturity as a result of unscheduled principal prepayment.
Prepayments on underlying mortgages result in a loss of anticipated
interest, and all or part of a premium if any has been paid, and the actual
yield (or total return) to a Fund may be different than the quoted yield on
the securities. Mortgage premiums generally increase with falling interest
rates and decrease with rising interest rates. Like other fixed income
securities, when interest rates rise the value of a mortgage pass-through
security generally will decline; however, when interest rates are declining,
the value of mortgage pass-through securities with prepayment features may
not increase as much as that of other fixed-income securities. In the event
of an increase in interest rates which results in a decline in mortgage
prepayments, the anticipated maturity of mortgage pass-through securities
held by a Fund may increase, effectively changing a security which was
considered short or intermediate-term at the time of purchase into a
long-term security. Long-term securities generally fluctuate more widely in
response to changes in interest rates than short or intermediate-term
securities.
Payment of principal and interest on some mortgage pass-through securities
(but not the market value of the securities themselves) may be guaranteed by
the full faith and credit of the U.S. Government (in the case of securities
guaranteed by the Government National Mortgage Association ("GNMA")); or
guaranteed by agencies or instrumentalities of the U.S. Government (such as
the Federal National Mortgage Association "FNMA") or the Federal Home Loan
Mortgage Corporation, ("FHLMC") which are supported only by the
discretionary authority of the U.S. Government to purchase the agency's
obligations). Mortgage pass-through securities may also be issued by
non-governmental issuers (such as commercial banks, savings and loan
institutions, private mortgage insurance companies, mortgage bankers and
other secondary market issuers). Some of these mortgage pass-through
securities may be supported by various forms of insurance or guarantees.
Interests in pools of mortgage-related securities differ from other forms
of debt securities, which normally provide for periodic payment of interest
in fixed amounts with principal payments at maturity or specified call
dates. Instead, these securities provide a monthly payment which consists of
both interest and principal payments. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on
their mortgage loans, net of any fees paid to the issuer or guarantor of
such securities. Additional payments are caused by prepayments of principal
resulting from the sale, refinancing or foreclosure of the underlying
property, net of fees or costs which may be incurred. Some mortgage
pass-through securities (such as securities issued by the GNMA) are
described as "modified pass-through." These securities entitle the holder to
receive all interests and principal payments owed on the mortgages in the
mortgage pool, net of certain fees, at the scheduled payment dates
regardless of whether the mortgagor actually makes the payment.
The principal governmental guarantor of mortgage pass-through securities
is GNMA. GNMA is a wholly owned U.S. Government corporation within the
Department of Housing and Urban Development. GNMA is authorized to
guarantee, with the full faith and credit of the U.S. Government, the timely
payment of principal and interest on securities issued by institutions
approved by GNMA (such as savings and loan institutions, commercial banks
and mortgage bankers) and backed by pools of Federal Housing Administration
("FHA") insured or Veterans Administration ("VA") guaranteed mortgages.
These guarantees, however, do not apply to the market value or yield of
mortgage pass-through securities. GNMA securities are often purchased at a
premium over the maturity value of the underlying mortgages. This premium is
not guaranteed and will be lost if prepayment occurs.
Government-related guarantors (i.e., whose guarantees are not backed by
the full faith and credit of the U.S. Government) include FNMA and FHLMC.
FNMA is a government-sponsored corporation owned entirely by private
stockholders. It is subject to general regulation by the Secretary of
Housing and Urban Development. FNMA purchases conventional residential
mortgages (i.e., mortgages not insured or guaranteed by any governmental
agency) from a list of approved seller/servicers which include state and
federally chartered savings and loan associations, mutual savings banks,
commercial banks, credit unions and mortgage bankers. Pass-through
securities issued by FNMA are guaranteed as to timely payment by FNMA of
principal and interest.
FHLMC is also a government-sponsored corporation owned by private
stockholders. FHLMC issues Participation Certificates ("PCs") which
represent interests in conventional mortgages (i.e., not federally insured
or guaranteed) for FHLMC's national portfolio. FHLMC guarantees timely
payment of interest and ultimate collection of principal regardless of the
status of the underlying mortgage loans.
Commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers and other secondary market issuers
also create pass through pools of mortgage loans. Such issuers may also be
the originators and/or servicers of the underlying mortgage-related
securities. Pools created by such non-governmental issuers generally offer a
higher rate of interest than government and government-related pools because
there are no direct or indirect government or agency guarantees of payments
in the former pools. However, timely payment of interest and principal of
mortgage loans in these pools may be supported by various forms of insurance
or guarantees, including individual loan, title, pool and hazard insurance
and letters of credit. The insurance and guarantees are issued by
governmental entities, private insurers and the mortgage poolers. There can
be no assurance that the private insurers or guarantors can meet their
obligations under the insurance policies or guarantee arrangements. A Fund
may also buy mortgage-related securities without insurance or guarantees.
STRIPPED MORTGAGE-BACKED SECURITIES: A Fund may invest a portion of its
assets in stripped mortgage-backed securities ("SMBS") which are derivative
multiclass mortgage securities issued by agencies or instrumentalities of
the U.S. Government, or by private originators of, or investors in, mortgage
loans, including savings and loan institutions, mortgage banks, commercial
banks and investment banks.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions from a pool of
mortgage assets. A common type of SMBS will have one class receiving some of
the interest and most of the principal from the Mortgage Assets, while the
other class will receive most of the interest and the remainder of the
principal. In the most extreme case, one class will receive all of the
interest (the interest-only or "I0" class) while the other class will
receive all of the principal (the principal-only or "P0" class). The yield
to maturity on an I0 is extremely sensitive to the rate of principal
payments, including prepayments on the related underlying Mortgage Assets,
and a rapid rate of principal payments may have a material adverse effect on
such security's yield to maturity. If the underlying Mortgage Assets
experience greater than anticipated prepayments of principal, a Fund may
fail to fully recoup its initial investment in these securities. The market
value of the class consisting primarily or entirely of principal payments
generally is unusually volatile in response to changes in interest rates.
Because SMBS were only recently introduced, established trading markets for
these securities have not yet developed, although the securities are traded
among institutional investors and investment banking firms.
CORPORATE SECURITIES: A Fund may invest in debt securities, such as
convertible and non-convertible bonds, notes and debentures, issued by
corporations, limited partnerships and other similar entities.
LOANS AND OTHER DIRECT INDEBTEDNESS: A Fund may purchase loans and other
direct indebtedness. In purchasing a loan, a Fund acquires some or all of
the interest of a bank or other lending institution in a loan to a
corporate, governmental or other borrower. Many such loans are secured,
although some may be unsecured. Such loans may be in default at the time of
purchase. Loans that are fully secured offer a Fund more protection than an
unsecured loan in the event of non-payment of scheduled interest or
principal. However, there is no assurance that the liquidation of collateral
from a secured loan would satisfy the corporate borrowers obligation, or
that the collateral can be liquidated.
These loans are made generally to finance internal growth, mergers,
acquisitions, stock repurchases, leveraged buy-outs and other corporate
activities. Such loans are typically made by a syndicate of lending
institutions, represented by an agent lending institution which has
negotiated and structured the loan and is responsible for collecting
interest, principal and other amounts due on its own behalf and on behalf of
the others in the syndicate, and for enforcing its and their other rights
against the borrower. Alternatively, such loans may be structured as a
novation, pursuant to which a Fund would assume all of the rights of the
lending institution in a loan or as an assignment, pursuant to which a Fund
would purchase an assignment of a portion of a lenders interest in a loan
either directly from the lender or through an intermediary. A Fund may also
purchase trade or other claims against companies, which generally represent
money owned by the company to a supplier of goods or services. These claims
may also be purchased at a time when the company is in default.
Certain of the loans and the other direct indebtedness acquired by a Fund
may involve revolving credit facilities or other standby financing
commitments which obligate a Fund to pay additional cash on a certain date
or on demand. These commitments may have the effect of requiring a Fund to
increase its investment in a company at a time when a Fund might not
otherwise decide to do so (including at a time when the company's financial
condition makes it unlikely that such amounts will be repaid). To the extent
that a Fund is committed to advance additional funds, it will at all times
hold and maintain in a segregated account cash or other high grade debt
obligations in an amount sufficient to meet such commitments.
A Fund's ability to receive payment of principal, interest and other
amounts due in connection with these investments will depend primarily on
the financial condition of the borrower. In selecting the loans and other
direct indebtedness which a Fund will purchase, the Adviser or Sub-Adviser
will rely upon its own (and not the original lending institution's) credit
analysis of the borrower. As a Fund may be required to rely upon another
lending institution to collect and pass onto a Fund amounts payable with
respect to the loan and to enforce a Fund's rights under the loan and other
direct indebtedness, an insolvency, bankruptcy or reorganization of the
lending institution may delay or prevent a Fund from receiving such amounts.
In such cases, a Fund will evaluate as well the creditworthiness of the
lending institution and will treat both the borrower and the lending
institution as an "issuer" of the loan for purposes of certain investment
restrictions pertaining to the diversification of a Fund's portfolio
investments. The highly leveraged nature of many such loans and other direct
indebtedness may make such loans and other direct indebtedness especially
vulnerable to adverse changes in economic or market conditions. Investments
in such loans and other direct indebtedness may involve additional risk to a
Fund.
LOWER RATED BONDS: A Fund may invest in fixed income securities rated Ba
or lower by Moody's or BB or lower by S&P, Fitch or Duff & Phelps and
comparable unrated securities (commonly known as "junk bonds"). See Appendix
D for a description of bond ratings. No minimum rating standard is required
by a Fund. These securities are considered speculative and, while generally
providing greater income than investments in higher rated securities, will
involve greater risk of principal and income (including the possibility of
default or bankruptcy of the issuers of such securities) and may involve
greater volatility of price (especially during periods of economic
uncertainty or change) than securities in the higher rating categories and
because yields vary over time, no specific level of income can ever be
assured. These lower rated high yielding fixed income securities generally
tend to reflect economic changes (and the outlook for economic growth),
short-term corporate and industry developments and the market's perception
of their credit quality (especially during times of adverse publicity) to a
greater extent than higher rated securities which react primarily to
fluctuations in the general level of interest rates (although these lower
rated fixed income securities are also affected by changes in interest
rates). In the past, economic downturns or an increase in interest rates
have, under certain circumstances, caused a higher incidence of default by
the issuers of these securities and may do so in the future, especially in
the case of highly leveraged issuers. The prices for these securities may be
affected by legislative and regulatory developments. The market for these
lower rated fixed income securities may be less liquid than the market for
investment grade fixed income securities. Furthermore, the liquidity of
these lower rated securities may be affected by the market's perception of
their credit quality. Therefore, the Adviser's or Sub-Adviser's judgment may
at times play a greater role in valuing these securities than in the case of
investment grade fixed income securities, and it also may be more difficult
during times of certain adverse market conditions to sell these lower rated
securities to meet redemption requests or to respond to changes in the
market.
While the Adviser or Sub-Adviser may refer to ratings issued by
established credit rating agencies, it is not a Fund's policy to rely
exclusively on ratings issued by these rating agencies, but rather to
supplement such ratings with the Adviser's or Sub-Adviser's own independent
and ongoing review of credit quality. To the extent a Fund invests in these
lower rated securities, the achievement of its investment objectives may be
more dependent on the Adviser's or Sub-Adviser's own credit analysis than in
the case of a fund investing in higher quality fixed income securities.
These lower rated securities may also include zero coupon bonds, deferred
interest bonds and PIK bonds.
MUNICIPAL BONDS: A Fund may invest in debt securities issued by or on
behalf of states, territories and possessions of the United States and the
District of Columbia and their political subdivisions, agencies or
instrumentalities, the interest on which is exempt from federal income tax
("Municipal Bonds"). Municipal Bonds include debt securities which pay
interest income that is subject to the alternative minimum tax. A Fund may
invest in Municipal Bonds whose issuers pay interest on the Bonds from
revenues from projects such as multifamily housing, nursing homes, electric
utility systems, hospitals or life care facilities.
If a revenue bond is secured by payments generated from a project, and the
revenue bond is also secured by a lien on the real estate comprising the
project, foreclosure by the indenture trustee on the lien for the benefit of
the bondholders creates additional risks associated with owning real estate,
including environmental risks.
Housing revenue bonds typically are issued by a state, county or local
housing authority and are secured only by the revenues of mortgages
originated by the authority using the proceeds of the bond issue. Because of
the impossibility of precisely predicting demand for mortgages from the
proceeds of such an issue, there is a risk that the proceeds of the issue
will be in excess of demand, which would result in early retirement of the
bonds by the issuer. Moreover, such housing revenue bonds depend for their
repayment upon the cash flow from the underlying mortgages, which cannot be
precisely predicted when the bonds are issued. Any difference in the actual
cash flow from such mortgages from the assumed cash flow could have an
adverse impact upon the ability of the issuer to make scheduled payments of
principal and interest on the bonds, or could result in early retirement of
the bonds. Additionally, such bonds depend in part for scheduled payments of
principal and interest upon reserve funds established from the proceeds of
the bonds, assuming certain rates of return on investment of such reserve
funds. If the assumed rates of return are not realized because of changes in
interest rate levels or for other reasons, the actual cash flow for
scheduled payments of principal and interest on the bonds may be inadequate.
The financing of multi-family housing projects is affected by a variety of
factors, including satisfactory completion of construction within cost
constraints, the achievement and maintenance of a sufficient level of
occupancy, sound management of the developments, timely and adequate
increases in rents to cover increases in operating expenses, including
taxes, utility rates and maintenance costs, changes in applicable laws and
governmental regulations and social and economic trends.
Electric utilities face problems in financing large construction programs
in inflationary periods, cost increases and delay occasioned by
environmental considerations (particularly with respect to nuclear
facilities), difficulty in obtaining fuel at reasonable prices, the cost of
competing fuel sources, difficulty in obtaining sufficient rate increases
and other regulatory problems, the effect of energy conservation and
difficulty of the capital market to absorb utility debt.
Health care facilities include life care facilities, nursing homes and
hospitals. Life care facilities are alternative forms of long-term housing
for the elderly which offer residents the independence of condominium life
style and, if needed, the comprehensive care of nursing home services. Bonds
to finance these facilities have been issued by various state industrial
development authorities. Since the bonds are secured only by the revenues of
each facility and not by state or local government tax payments, they are
subject to a wide variety of risks. Primarily, the projects must maintain
adequate occupancy levels to be able to provide revenues adequate to
maintain debt service payments. Moreover, in the case of life care
facilities, since a portion of housing, medical care and other services may
be financed by an initial deposit, there may be risk if the facility does
not maintain adequate financial reserves to secure estimated actuarial
liabilities. The ability of management to accurately forecast inflationary
cost pressures weighs importantly in this process. The facilities may also
be affected by regulatory cost restrictions applied to health care delivery
in general, particularly state regulations or changes in Medicare and
Medicaid payments or qualifications, or restrictions imposed by medical
insurance companies. They may also face competition from alternative health
care or conventional housing facilities in the private or public sector.
Hospital bond ratings are often based on feasibility studies which contain
projections of expenses, revenues and occupancy levels. A hospital's gross
receipts and net income available to service its debt are influenced by
demand for hospital services, the ability of the hospital to provide the
services required, management capabilities, economic developments in the
service area, efforts by insurers and government agencies to limit rates and
expenses, confidence in the hospital, service area economic developments,
competition, availability and expense of malpractice insurance, Medicaid and
Medicare funding, and possible federal legislation limiting the rates of
increase of hospital charges.
A Fund may invest in municipal lease securities. These are undivided
interests in a portion of an obligation in the from of a lease or
installment purchase which is issued by state and local governments to
acquire equipment and facilities. Municipal leases frequently have special
risks not normally associated with general obligation or revenue bonds.
Leases and installment purchase or conditional sale contracts (which
normally provide for title to the leased asset to pass eventually to the
governmental issuer) have evolved as a means for governmental issuers to
acquire property and equipment without meeting the constitutional and
statutory requirements for the issuance of debt. The debt-issuance
limitations are deemed to be inapplicable because of the inclusion in many
leases or contracts of "non-appropriation" clauses that provide that the
governmental issuer has no obligation to make future payments under the
lease or contract unless money is appropriated for such purpose by the
appropriate legislative body on a yearly or other periodic basis. Although
the obligations will be secured by the leased equipment or facilities, the
disposition of the property in the event of non-appropriation or foreclosure
might, in some cases, prove difficult. There are, of course, variations in
the security of municipal lease securities, both within a particular
classification and between classifications, depending on numerous factors.
A Fund may also invest in bonds for industrial and other projects, such as
sewage or solid waste disposal or hazardous waste treatment facilities.
Financing for such projects will be subject to inflation and other general
economic factors as well as construction risks including labor problems,
difficulties with construction sites and the ability of contractors to meet
specifications in a timely manner. Because some of the materials, processes
and wastes involved in these projects may include hazardous components,
there are risks associated with their production, handling and disposal.
SPECULATIVE BONDS: A Fund may invest in fixed income and convertible
securities rated Baa by Moody's or BBB by S&P, Fitch or Duff & Phelps and
comparable unrated securities. See Appendix D for a description of bond
ratings. These securities, while normally exhibiting adequate protection
parameters, have speculative characteristics and changes in economic
conditions or other circumstances are more likely to lead to a weakened
capacity to make principal and interest payments than in the case of higher
grade securities.
U.S. GOVERNMENT SECURITIES: A Fund may invest in U.S. Government
Securities including (i) U.S. Treasury obligations, all of which are backed
by the full faith and credit of the U.S. Government and (ii) U.S. Government
Securities, some of which are backed by the full faith and credit of the
U.S. Treasury, e.g., direct pass-through certificates of the GNMA; some of
which are backed only by the credit of the issuer itself, e.g., obligations
of the Student Loan Marketing Association; and some of which are supported
by the discretionary authority of the U.S. Government to purchase the
agency's obligations, e.g., obligations of the FNMA.
U.S. Government Securities also include interests in trust or other
entities representing interests in obligations that are issued or
guaranteed by the U.S. Government, its agencies, authorities or
instrumentalities.
VARIABLE AND FLOATING RATE OBLIGATIONS: A Fund may invest in floating or
variable rate securities. Investments in floating or variable rate
securities normally will involve industrial development or revenue bonds
which provide that the rate of interest is set as a specific percentage of a
designated base rate, such as rates on Treasury Bonds or Bills or the prime
rate at a major commercial bank, and that a bondholder can demand payment of
the obligations on behalf of a Fund on short notice at par plus accrued
interest, which amount may be more or less than the amount the bondholder
paid for them. The maturity of floating or variable rate obligations
(including participation interests therein) is deemed to be the longer of
(i) the notice period required before a Fund is entitled to receive payment
of the obligation upon demand or (ii) the period remaining until the
obligation's next interest rate adjustment. If not redeemed by a Fund
through the demand feature, the obligations mature on a specified date which
may range up to thirty years from the date of issuance.
ZERO COUPON BONDS, DEFERRED INTEREST BONDS AND PIK BONDS: A Fund may
invest in zero coupon bonds, deferred interest bonds and bonds on which the
interest is payable in kind ("PIK bonds"). Zero coupon and deferred interest
bonds are debt obligations which are issued at a significant discount from
face value. The discount approximates the total amount of interest the bonds
will accrue and compound over the period until maturity or the first
interest payment date at a rate of interest reflecting the market rate of
the security at the time of issuance. While zero coupon bonds do not require
the periodic payment of interest, deferred interest bonds provide for a
period of delay before the regular payment of interest begins. PIK bonds are
debt obligations which provide that the issuer may, at its option, pay
interest on such bonds in cash or in the form of additional debt
obligations. Such investments benefit the issuer by mitigating its need for
cash to meet debt service, but also require a higher rate of return to
attract investors who are willing to defer receipt of such cash. Such
investments may experience greater volatility in market value than debt
obligations which make regular payments of interest. A Fund will accrue
income on such investments for tax and accounting purposes, which is
distributable to shareholders and which, because no cash is received at the
time of accrual, may require the liquidation of other portfolio securities
to satisfy a Fund's distribution obligations.
EQUITY SECURITIES
A Fund may invest in all types of equity securities, including the
following: common stocks, preferred stocks and preference stocks; securities
such as bonds, warrants or rights that are convertible into stocks; and
depositary receipts for those securities. These securities may be listed on
securities exchanges, traded in various over-the-counter markets or have no
organized market.
FOREIGN SECURITIES EXPOSURE
A Fund may invest in various types of foreign securities, or securities
which provide a Fund with exposure to foreign securities or foreign
currencies, as discussed below:
BRADY BONDS: A Fund may invest in Brady Bonds, which are securities created
through the exchange of existing commercial bank loans to public and private
entities in certain emerging markets for new bonds in connection with debt
restructurings under a debt restructuring plan introduced by former U.S.
Secretary of the Treasury, Nicholas F. Brady (the "Brady Plan"). Brady Plan
debt restructurings have been implemented to date in Argentina, Brazil,
Bulgaria, Costa Rica, Croatia, Dominican Republic, Ecuador, Jordan, Mexico,
Morocco, Nigeria, Panama, Peru, the Philippines, Poland, Slovenia, Uruguay
and Venezuela. Brady Bonds have been issued only recently, and for that
reason do not have a long payment history. Brady Bonds may be collateralized
or uncollateralized, are issued in various currencies (but primarily the
U.S. dollar) and are actively traded in over-the-counter secondary markets.
U.S. dollar-denominated, collateralized Brady Bonds, which may be fixed rate
bonds or floating-rate bonds, are generally collateralized in full as to
principal by U.S. Treasury zero coupon bonds having the same maturity as the
bonds. Brady Bonds are often viewed as having three or four valuation
components: the collateralized repayment of principal at final maturity; the
collateralized interest payments; the uncollateralized interest payments;
and any uncollateralized repayment of principal at maturity (these
uncollateralized amounts constituting the "residual risk"). In light of the
residual risk of Brady Bonds and the history of defaults of countries
issuing Brady Bonds with respect to commercial bank loans by public and
private entities, investments in Brady Bonds may be viewed as speculative.
DEPOSITARY RECEIPTS: A Fund may invest in American Depositary Receipts
("ADRs"), Global Depositary Receipts ("GDRs") and other types of depositary
receipts. ADRs are certificates by a U.S. depositary (usually a bank) and
represent a specified quantity of shares of an underlying non-U.S. stock on
deposit with a custodian bank as collateral. GDRs and other types of
depositary receipts are typically issued by foreign banks or trust companies
and evidence ownership of underlying securities issued by either a foreign
or a U.S. company. Generally, ADRs are in registered form and are designed
for use in U.S. securities markets and GDRs are in bearer form and are
designed for use in foreign securities markets. For the purposes of a Fund's
policy to invest a certain percentage of its assets in foreign securities,
the investments of a Fund in ADRs, GDRs and other types of depositary
receipts are deemed to be investments in the underlying securities.
ADRs may be sponsored or unsponsored. A sponsored ADR is issued by a
depositary which has an exclusive relationship with the issuer of the
underlying security. An unsponsored ADR may be issued by any number of U.S.
depositories. Under the terms of most sponsored arrangements, depositories
agree to distribute notices of shareholder meetings and voting instructions,
and to provide shareholder communications and other information to the ADR
holders at the request of the issuer of the deposited securities. The
depository of an unsponsored ADR, on the other hand, is under no obligation
to distribute shareholder communications received from the issuer of the
deposited securities or to pass through voting rights to ADR holders in
respect of the deposited securities. A Fund may invest in either type of
ADR. Although the U.S. investor holds a substitute receipt of ownership
rather than direct stock certificates, the use of the depositary receipts in
the United States can reduce costs and delays as well as potential currency
exchange and other difficulties. A Fund may purchase securities in local
markets and direct delivery of these ordinary shares to the local depositary
of an ADR agent bank in foreign country. Simultaneously, the ADR agents
create a certificate which settles at a Fund's custodian in five days. A
Fund may also execute trades on the U.S. markets using existing ADRs. A
foreign issuer of the security underlying an ADR is generally not subject to
the same reporting requirements in the United States as a domestic issuer.
Accordingly, information available to a U.S. investor will be limited to the
information the foreign issuer is required to disclose in its country and
the market value of an ADR may not reflect undisclosed material information
concerning the issuer of the underlying security. ADRs may also be subject
to exchange rate risks if the underlying foreign securities are denominated
in a foreign currency.
DOLLAR-DENOMINATED FOREIGN DEBT SECURITIES: A Fund may invest in
dollar-denominated foreign debt securities. Investing in dollar-denominated
foreign debt represents a greater degree of risk than investing in domestic
securities, due to less publicly available information, less securities
regulation, war or expropriation. Special considerations may include higher
brokerage costs and thinner trading markets. Investments in foreign
countries could be affected by other factors including extended settlement
periods.
EMERGING MARKETS: A Fund may invest in securities of government,
government-related, supranational and corporate issuers located in emerging
markets. Emerging markets include any country determined by the Adviser to
have an emerging market economy, taking into account a number of factors,
including whether the country has a low- to middle-income economy according
to the International Bank for Reconstruction and Development, the country's
foreign currency debt rating, its political and economic stability and the
development of its financial and capital markets. The Adviser determines
whether an issuer's principal activities are located in an emerging market
country by considering such factors as its country of organization, the
principal trading market for its securities, the source of its revenues and
location of its assets. Such investments entail significant risks as
described below.
o Company Debt -- Governments of many emerging market countries have
exercised and continue to exercise substantial influence over many
aspects of the private sector through the ownership or control of many
companies, including some of the largest in any given country. As a
result, government actions in the future could have a significant effect
on economic conditions in emerging markets, which in turn, may adversely
affect companies in the private sector, general market conditions and
prices and yields of certain of the securities in a Fund's portfolio.
Expropriation, confiscatory taxation, nationalization, political,
economic or social instability or other similar developments have
occurred frequently over the history of certain emerging markets and
could adversely affect a Fund's assets should these conditions recur.
o Default; Legal Recourse -- A Fund may have limited legal recourse in the
event of a default with respect to certain debt obligations it may hold.
If the issuer of a fixed income security owned by a Fund defaults, a
Fund may incur additional expenses to seek recovery. Debt obligations
issued by emerging market governments differ from debt obligations of
private entities; remedies from defaults on debt obligations issued by
emerging market governments, unlike those on private debt, must be
pursued in the courts of the defaulting party itself. A Fund's ability
to enforce its rights against private issuers may be limited. The
ability to attach assets to enforce a judgment may be limited. Legal
recourse is therefore somewhat diminished. Bankruptcy, moratorium and
other similar laws applicable to private issuers of debt obligations may
be substantially different from those of other countries. The political
context, expressed as an emerging market governmental issuer's
willingness to meet the terms of the debt obligation, for example, is of
considerable importance. In addition, no assurance can be given that the
holders of commercial bank debt may not contest payments to the holders
of debt obligations in the event of default under commercial bank loan
agreements.
o Foreign Currencies -- The securities in which a Fund invests may be
denominated in foreign currencies and international currency units and a
Fund may invest a portion of its assets directly in foreign currencies.
Accordingly, the weakening of these currencies and units against the
U.S. dollar may result in a decline in a Fund's asset value.
Some emerging market countries also may have managed currencies, which
are not free floating against the U.S. dollar. In addition, there is
risk that certain emerging market countries may restrict the free
conversion of their currencies into other currencies. Further, certain
emerging market currencies may not be internationally traded. Certain of
these currencies have experienced a steep devaluation relative to the
U.S. dollar. Any devaluations in the currencies in which a Fund's
portfolio securities are denominated may have a detrimental impact on a
Fund's net asset value.
o Inflation -- Many emerging markets have experienced substantial, and in
some periods extremely high, rates of inflation for many years.
Inflation and rapid fluctuations in inflation rates have had and may
continue to have adverse effects on the economies and securities markets
of certain emerging market countries. In an attempt to control
inflation, wage and price controls have been imposed in certain
countries. Of these countries, some, in recent years, have begun to
control inflation through prudent economic policies.
o Liquidity; Trading Volume; Regulatory Oversight -- The securities
markets of emerging market countries are substantially smaller, less
developed, less liquid and more volatile than the major securities
markets in the U.S. Disclosure and regulatory standards are in many
respects less stringent than U.S. standards. Furthermore, there is a
lower level of monitoring and regulation of the markets and the
activities of investors in such markets.
The limited size of many emerging market securities markets and limited
trading volume in the securities of emerging market issuers compared to
volume of trading in the securities of U.S. issuers could cause prices to be
erratic for reasons apart from factors that affect the soundness and
competitiveness of the securities issuers. For example, limited market size
may cause prices to be unduly influenced by traders who control large
positions. Adverse publicity and investors' perceptions, whether or not
based on in-depth fundamental analysis, may decrease the value and liquidity
of portfolio securities.
The risk also exists that an emergency situation may arise in one or more
emerging markets, as a result of which trading of securities may cease or
may be substantially curtailed and prices for a Fund's securities in such
markets may not be readily available. A Fund may suspend redemption of its
shares for any period during which an emergency exists, as determined by the
Securities and Exchange Commission (the "SEC"). Accordingly, if a Fund
believes that appropriate circumstances exist, it will promptly apply to the
SEC for a determination that an emergency is present. During the period
commencing from a Fund's identification of such condition until the date of
the SEC action, a Fund's securities in the affected markets will be valued
at fair value determined in good faith by or under the direction of the
Board of Trustees.
o Sovereign Debt -- Investment in sovereign debt can involve a high degree
of risk. The governmental entity that controls the repayment of
sovereign debt may not be able or willing to repay the principal and/or
interest when due in accordance with the terms of such debt. A
governmental entity's willingness or ability to repay principal and
interest due in a timely manner may be affected by, among other factors,
its cash flow situation, the extent of its foreign reserves, the
availability of sufficient foreign exchange on the date a payment is
due, the relative size of the debt service burden to the economy as a
whole, the governmental entity's policy towards the International
Monetary Fund and the political constraints to which a governmental
entity may be subject. Governmental entities may also be dependent on
expected disbursements from foreign governments, multilateral agencies
and others abroad to reduce principal and interest on their debt. The
commitment on the part of these governments, agencies and others to make
such disbursements may be conditioned on a governmental entity's
implementation of economic reforms and/or economic performance and the
timely service of such debtor's obligations. Failure to implement such
reforms, achieve such levels of economic performance or repay principal
or interest when due may result in the cancellation of such third
parties' commitments to lend funds to the governmental entity, which may
further impair such debtor's ability or willingness to service its debts
in a timely manner. Consequently, governmental entities may default on
their sovereign debt. Holders of sovereign debt (including a Fund) may
be requested to participate in the rescheduling of such debt and to
extend further loans to governmental entities. There is no bankruptcy
proceedings by which sovereign debt on which governmental entities have
defaulted may be collected in whole or in part.
Emerging market governmental issuers are among the largest debtors to
commercial banks, foreign governments, international financial
organizations and other financial institutions. Certain emerging market
governmental issuers have not been able to make payments of interest on
or principal of debt obligations as those payments have come due.
Obligations arising from past restructuring agreements may affect the
economic performance and political and social stability of those
issuers.
The ability of emerging market governmental issuers to make timely
payments on their obligations is likely to be influenced strongly by the
issuer's balance of payments, including export performance, and its
access to international credits and investments. An emerging market
whose exports are concentrated in a few commodities could be vulnerable
to a decline in the international prices of one or more of those
commodities. Increased protectionism on the part of an emerging market's
trading partners could also adversely affect the country's exports and
tarnish its trade account surplus, if any. To the extent that emerging
markets receive payment for their exports in currencies other than
dollars or non-emerging market currencies, its ability to make debt
payments denominated in dollars or non-emerging market currencies could
be affected.
To the extent that an emerging market country cannot generate a trade
surplus, it must depend on continuing loans from foreign governments,
multilateral organizations or private commercial banks, aid payments
from foreign governments and on inflows of foreign investment. The
access of emerging markets to these forms of external funding may not be
certain, and a withdrawal of external funding could adversely affect the
capacity of emerging market country governmental issuers to make
payments on their obligations. In addition, the cost of servicing
emerging market debt obligations can be affected by a change in
international interest rates since the majority of these obligations
carry interest rates that are adjusted periodically based upon
international rates.
Another factor bearing on the ability of emerging market countries to
repay debt obligations is the level of international reserves of the
country. Fluctuations in the level of these reserves affect the amount
of foreign exchange readily available for external debt payments and
thus could have a bearing on the capacity of emerging market countries
to make payments on these debt obligations.
o Withholding -- Income from securities held by a Fund could be reduced by
a withholding tax on the source or other taxes imposed by the emerging
market countries in which a Fund makes its investments. A Fund's net
asset value may also be affected by changes in the rates or methods of
taxation applicable to a Fund or to entities in which a Fund has
invested. The Adviser or Sub-Adviser will consider the cost of any taxes
in determining whether to acquire any particular investments, but can
provide no assurance that the taxes will not be subject to change.
FOREIGN SECURITIES: A Fund may invest in dollar-denominated and non
dollar-denominated foreign securities. The issuer's principal activities
generally are deemed to be located in a particular country if: (a) the
security is issued or guaranteed by the government of that country or any of
its agencies, authorities or instrumentalities; (b) the issuer is organized
under the laws of, and maintains a principal office in, that country; (c)
the issuer has its principal securities trading market in that country; (d)
the issuer derives 50% or more of its total revenues from goods sold or
services performed in that country; or (e) the issuer has 50 or more of its
assets in that country.
Investing in securities of foreign issuers generally involves risks not
ordinarily associated with investing in securities of domestic issuers.
These include changes in currency rates, exchange control regulations,
securities settlement practices, governmental administration or economic or
monetary policy (in the United States or abroad) or circumstances in
dealings between nations. Costs may be incurred in connection with
conversions between various currencies. Special considerations may also
include more limited information about foreign issuers, higher brokerage
costs, different accounting standards and thinner trading markets. Foreign
securities markets may also be less liquid, more volatile and less subject
to government supervision than in the United States. Investments in foreign
countries could be affected by other factors including expropriation,
confiscatory taxation and potential difficulties in enforcing contractual
obligations and could be subject to extended settlement periods. As a result
of its investments in foreign securities, a Fund may receive interest or
dividend payments, or the proceeds of the sale or redemption of such
securities, in the foreign currencies in which such securities are
denominated. Under certain circumstances, such as where the Adviser believes
that the applicable exchange rate is unfavorable at the time the currencies
are received or the Adviser or Sub- Adviser anticipates, for any other
reason, that the exchange rate will improve, a Fund may hold such currencies
for an indefinite period of time. While the holding of currencies will
permit a Fund to take advantage of favorable movements in the applicable
exchange rate, such strategy also exposes a Fund to risk of loss if exchange
rates move in a direction adverse to a Fund's position. Such losses could
reduce any profits or increase any losses sustained by a Fund from the sale
or redemption of securities and could reduce the dollar value of interest or
dividend payments received. The Fund's investments in foreign securities may
also include "privatizations". Privatizations are situations where the
government in a given country, including emerging market countries, sells
part or all of its stakes in government owned or controlled enterprises. In
certain countries, the ability of foreign entities to participate in
privatizations may be limited by local law and the terms on which the
foreign entities may be permitted to participate may be less advantageous
than those afforded local investors.
FORWARD CONTRACTS
A Fund may enter into contracts for the purchase or sale of a specific
currency at a future date at a price set at the time the contract is entered
into (a "Forward Contract"), for hedging purposes (e.g., to protect its
current or intended investments from fluctuations in currency exchange
rates) as well as for non-hedging purposes.
A Forward Contract to sell a currency may be entered into where a Fund
seeks to protect against an anticipated increase in the exchange rate for a
specific currency which could reduce the dollar value of portfolio
securities denominated in such currency. Conversely, a Fund may enter into a
Forward Contract to purchase a given currency to protect against a projected
increase in the dollar value of securities denominated in such currency
which a Fund intends to acquire.
If a hedging transaction in Forward Contracts is successful, the decline
in the dollar value of portfolio securities or the increase in the dollar
cost of securities to be acquired may be offset, at least in part, by
profits on the Forward Contract. Nevertheless, by entering into such Forward
Contracts, a Fund may be required to forego all or a portion of the benefits
which otherwise could have been obtained from favorable movements in
exchange rates. A Fund does not presently intend to hold Forward Contracts
entered into until the value date, at which time it would be required to
deliver or accept delivery of the underlying currency, but will seek in most
instances to close out positions in such Contracts by entering into
offsetting transactions, which will serve to fix a Fund's profit or loss
based upon the value of the Contracts at the time the offsetting transaction
is executed.
A Fund will also enter into transactions in Forward Contracts for other
than hedging purposes, which presents greater profit potential but also
involves increased risk. For example, a Fund may purchase a given foreign
currency through a Forward Contract if, in the judgment of the Adviser, the
value of such currency is expected to rise relative to the U.S. dollar.
Conversely, a Fund may sell the currency through a Forward Contract if the
Adviser believes that its value will decline relative to the dollar.
A Fund will profit if the anticipated movements in foreign currency
exchange rates occur, which will increase its gross income. Where exchange
rates do not move in the direction or to the extent anticipated, however, a
Fund may sustain losses which will reduce its gross income. Such
transactions, therefore, could be considered speculative and could involve
significant risk of loss.
The use by a Fund of Forward Contracts also involves the risks described
under the caption "Special Risk Factors -- Options, Futures, Forwards, Swaps
and Other Derivative Transactions" in this Appendix.
FUTURES CONTRACTS
A Fund may purchase and sell futures contracts ("Futures Contracts") on
stock indices, foreign currencies, interest rates or interest-rate related
instruments, indices of foreign currencies or commodities. A Fund may also
purchase and sell Futures Contracts on foreign or domestic fixed income
securities or indices of such securities including municipal bond indices
and any other indices of foreign or domestic fixed income securities that
may become available for trading. Such investment strategies will be used
for hedging purposes and for non-hedging purposes, subject to applicable
law.
A Futures Contract is a bilateral agreement providing for the purchase and
sale of a specified type and amount of a financial instrument, foreign
currency or commodity, or for the making and acceptance of a cash
settlement, at a stated time in the future for a fixed price. By its terms,
a Futures Contract provides for a specified settlement month in which, in
the case of the majority of commodities, interest rate and foreign currency
futures contracts, the underlying commodities, fixed income securities or
currency are delivered by the seller and paid for by the purchaser, or on
which, in the case of index futures contracts and certain interest rate and
foreign currency futures contracts, the difference between the price at
which the contract was entered into and the contract's closing value is
settled between the purchaser and seller in cash. Futures Contracts differ
from options in that they are bilateral agreements, with both the purchaser
and the seller equally obligated to complete the transaction. Futures
Contracts call for settlement only on the expiration date and cannot be
"exercised" at any other time during their term.
The purchase or sale of a Futures Contract differs from the purchase or
sale of a security or the purchase of an option in that no purchase price is
paid or received. Instead, an amount of cash or cash equivalents, which
varies but may be as low as 5% or less of the value of the contract, must be
deposited with the broker as "initial margin." Subsequent payments to and
from the broker, referred to as "variation margin," are made on a daily
basis as the value of the index or instrument underlying the Futures
Contract fluctuates, making positions in the Futures Contract more or less
valuable -- a process known as "mark-to-market."
Purchases or sales of stock index futures contracts are used to attempt to
protect a Fund's current or intended stock investments from broad
fluctuations in stock prices. For example, a Fund may sell stock index
futures contracts in anticipation of or during a market decline to attempt
to offset the decrease in market value of a Fund's securities portfolio that
might otherwise result. If such decline occurs, the loss in value of
portfolio securities may be offset, in whole or part, by gains on the
futures position. When a Fund is not fully invested in the securities market
and anticipates a significant market advance, it may purchase stock index
futures contracts in order to gain rapid market exposure that may, in part
or entirely, offset increases in the cost of securities that a Fund intends
to purchase. As such purchases are made, the corresponding positions in
stock index futures contracts will be closed out. In a substantial majority
of these transactions, a Fund will purchase such securities upon termination
of the futures position, but under unusual market conditions, a long futures
position may be terminated without a related purchase of securities.
Interest rate Futures Contracts may be purchased or sold to attempt to
protect against the effects of interest rate changes on a Fund's current or
intended investments in fixed income securities. For example, if a Fund
owned long-term bonds and interest rates were expected to increase, a Fund
might enter into interest rate futures contracts for the sale of debt
securities. Such a sale would have much the same effect as selling some of
the long-term bonds in a Fund's portfolio. If interest rates did increase,
the value of the debt securities in the portfolio would decline, but the
value of a Fund's interest rate futures contracts would increase at
approximately the same rate, subject to the correlation risks described
below, thereby keeping the net asset value of a Fund from declining as much
as it otherwise would have.
Similarly, if interest rates were expected to decline, interest rate
futures contracts may be purchased to hedge in anticipation of subsequent
purchases of long-term bonds at higher prices. Since the fluctuations in the
value of the interest rate futures contracts should be similar to that of
long-term bonds, a Fund could protect itself against the effects of the
anticipated rise in the value of long-term bonds without actually buying
them until the necessary cash became available or the market had stabilized.
At that time, the interest rate futures contracts could be liquidated and a
Fund's cash reserves could then be used to buy long-term bonds on the cash
market. A Fund could accomplish similar results by selling bonds with long
maturities and investing in bonds with short maturities when interest rates
are expected to increase. However, since the futures market may be more
liquid than the cash market in certain cases or at certain times, the use of
interest rate futures contracts as a hedging technique may allow a Fund to
hedge its interest rate risk without having to sell its portfolio
securities.
A Fund may purchase and sell foreign currency futures contracts for
hedging purposes, to attempt to protect its current or intended investments
from fluctuations in currency exchange rates. Such fluctuations could reduce
the dollar value of portfolio securities denominated in foreign currencies,
or increase the dollar cost of foreign-denominated securities to be
acquired, even if the value of such securities in the currencies in which
they are denominated remains constant. A Fund may sell futures contracts on
a foreign currency, for example, where it holds securities denominated in
such currency and it anticipates a decline in the value of such currency
relative to the dollar. In the event such decline occurs, the resulting
adverse effect on the value of foreign-denominated securities may be offset,
in whole or in part, by gains on the futures contracts.
Conversely, a Fund could protect against a rise in the dollar cost of
foreign-denominated securities to be acquired by purchasing futures
contracts on the relevant currency, which could offset, in whole or in part,
the increased cost of such securities resulting from a rise in the dollar
value of the underlying currencies. Where a Fund purchases futures contracts
under such circumstances, however, and the prices of securities to be
acquired instead decline, a Fund will sustain losses on its futures position
which could reduce or eliminate the benefits of the reduced cost of
portfolio securities to be acquired.
The use by a Fund of Futures Contracts also involves the risks described
under the caption "Special Risk Factors -- Options, Futures, Forwards, Swaps
and Other Derivative Transactions" in this Appendix.
INDEXED SECURITIES
A Fund may purchase securities with principal and/or interest payments whose
prices are indexed to the prices of other securities, securities indices,
currencies, precious metals or other commodities, or other financial
indicators. Indexed securities typically, but not always, are debt
securities or deposits whose value at maturity or coupon rate is determined
by reference to a specific instrument or statistic. A Fund may also purchase
indexed deposits with similar characteristics. Gold-indexed securities, for
example, typically provide for a maturity value that depends on the price of
gold, resulting in a security whose price tends to rise and fall together
with gold prices. Currency-indexed securities typically are short-term to
intermediate-term debt securities whose maturity values or interest rates
are determined by reference to the values of one or more specified foreign
currencies, and may offer higher yields than U.S. dollar denominated
securities of equivalent issuers. Currency-indexed securities may be
positively or negatively indexed; that is, their maturity value may increase
when the specified currency value increases, resulting in a security that
performs similarly to a foreign-denominated instrument, or their maturity
value may decline when foreign currencies increase, resulting in a security
whose price characteristics are similar to a put on the underlying currency.
Currency-indexed securities may also have prices that depend on the values
of a number of different foreign currencies relative to each other. Certain
indexed securities may expose a Fund to the risk of loss of all or a portion
of the principal amount of its investment and/or the interest that might
otherwise have been earned on the amount invested.
The performance of indexed securities depends to a great extent on the
performance of the security, currency, or other instrument to which they are
indexed, and may also be influenced by interest rate changes in the U.S. and
abroad. At the same time, indexed securities are subject to the credit risks
associated with the issuer of the security, and their values may decline
substantially if the issuer's creditworthiness deteriorates. Recent issuers
of indexed securities have included banks, corporations, and certain U.S.
Government-sponsored entities.
INVERSE FLOATING RATE OBLIGATIONS
A Fund may invest in so-called "inverse floating rate obligations" or
"residual interest bonds" or other obligations or certificates relating
thereto structured to have similar features. In creating such an obligation,
a municipality issues a certain amount of debt and pays a fixed interest
rate. Half of the debt is issued as variable rate short term obligations,
the interest rate of which is reset at short intervals, typically 35 days.
The other half of the debt is issued as inverse floating rate obligations,
the interest rate of which is calculated based on the difference between a
multiple of (approximately two times) the interest paid by the issuer and
the interest paid on the short-term obligation. Under usual circumstances,
the holder of the inverse floating rate obligation can generally purchase an
equal principal amount of the short term obligation and link the two
obligations in order to create long-term fixed rate bonds. Because the
interest rate on the inverse floating rate obligation is determined by
subtracting the short-term rate from a fixed amount, the interest rate will
decrease as the short-term rate increases and will increase as the
short-term rate decreases. The magnitude of increases and decreases in the
market value of inverse floating rate obligations may be approximately twice
as large as the comparable change in the market value of an equal principal
amount of long-term bonds which bear interest at the rate paid by the issuer
and have similar credit quality, redemption and maturity provisions.
INVESTMENT IN OTHER INVESTMENT COMPANIES
A Fund may invest in other investment companies. The total return on such
investment will be reduced by the operating expenses and fees of such other
investment companies, including advisory fees.
OPEN-END FUNDS. A Fund may invest in open-end investment companies.
CLOSED-END FUNDS. A Fund may invest in closed-end investment companies.
Such investment may involve the payment of substantial premiums above the
value of such investment companies' portfolio securities.
LENDING OF PORTFOLIO SECURITIES
A Fund may seek to increase its income by lending portfolio securities. Such
loans will usually be made only to member firms of the New York Stock
Exchange (the "Exchange") (and subsidiaries thereof) and member banks of the
Federal Reserve System, and would be required to be secured continuously by
collateral in cash, an irrevocable letter of credit or United States
("U.S.") Treasury securities maintained on a current basis at an amount at
least equal to the market value of the securities loaned. A Fund would have
the right to call a loan and obtain the securities loaned at any time on
customary industry settlement notice (which will not usually exceed five
business days). For the duration of a loan, a Fund would continue to receive
the equivalent of the interest or dividends paid by the issuer on the
securities loaned. A Fund would also receive a fee from the borrower or
compensation from the investment of the collateral, less a fee paid to the
borrower (if the collateral is in the form of cash). A Fund would not,
however, have the right to vote any securities having voting rights during
the existence of the loan, but a Fund would call the loan in anticipation of
an important vote to be taken among holders of the securities or of the
giving or withholding of their consent on a material matter affecting the
investment. As with other extensions of credit there are risks of delay in
recovery or even loss of rights in the collateral should the borrower of the
securities fail financially. However, the loans would be made only to firms
deemed by the Adviser or Sub-Adviser to be of good standing, and when, in
the judgment of the Adviser or Sub-Adviser, the consideration which can be
earned currently from securities loans of this type justifies the attendant
risk.
LEVERAGING TRANSACTIONS
A Fund may engage in the types of transactions described below, which
involve "leverage" because in each case a Fund receives cash which it can
invest in portfolio securities and has a future obligation to make a
payment. The use of these transactions by a Fund will generally cause its
net asset value to increase or decrease at a greater rate than would
otherwise be the case. Any investment income or gains earned from the
portfolio securities purchased with the proceeds from these transactions
which is in excess of the expenses associated from these transactions can be
expected to cause the value of a Fund's shares and distributions on a Fund's
shares to rise more quickly than would otherwise be the case. Conversely, if
the investment income or gains earned from the portfolio securities
purchased with proceeds from these transactions fail to cover the expenses
associated with these transactions, the value of a Fund's shares is likely
to decrease more quickly than otherwise would be the case and distributions
thereon will be reduced or eliminated. Hence, these transactions are
speculative, involve leverage and increase the risk of owning or investing
in the shares of a Fund. These transactions also increase a Fund's expenses
because of interest and similar payments and administrative expenses
associated with them. Unless the appreciation and income on assets purchased
with proceeds from these transactions exceed the costs associated with them,
the use of these transactions by a Fund would diminish the investment
performance of a Fund compared with what it would have been without using
these transactions.
BANK BORROWINGS: A Fund may borrow money for investment purposes from
banks and invest the proceeds in accordance with its investment objectives
and policies.
MORTGAGE "DOLLAR ROLL" TRANSACTIONS: A Fund may enter into mortgage "dollar
roll" transactions pursuant to which it sells mortgage-backed securities for
delivery in the future and simultaneously contracts to repurchase
substantially similar securities on a specified future date. During the roll
period, a Fund foregoes principal and interest paid on the mortgage-backed
securities. A Fund is compensated for the lost interest by the difference
between the current sales price and the lower price for the future purchase
(often referred to as the "drop") as well as by the interest earned on, and
gains from, the investment of the cash proceeds of the initial sale. A Fund
may also be compensated by receipt of a commitment fee.
If the income and capital gains from a Fund's investment of the cash from
the initial sale do not exceed the income, capital appreciation and gain or
loss that would have been realized on the securities sold as part of the
dollar roll, the use of this technique will diminish the investment
performance of a Fund compared with what the performance would have been
without the use of the dollar rolls. Dollar roll transactions involve the
risk that the market value of the securities a Fund is required to purchase
may decline below the agreed upon repurchase price of those securities. If
the broker/dealer to whom a Fund sells securities becomes insolvent, a
Fund's right to purchase or repurchase securities may be restricted.
Successful use of mortgage dollar rolls may depend upon the Adviser's or
Sub-Adviser's ability to correctly predict interest rates and prepayments.
There is no assurance that dollar rolls can be successfully employed.
REVERSE REPURCHASE AGREEMENTS: A Fund may enter into reverse repurchase
agreements. In a reverse repurchase agreement, a Fund will sell securities
and receive cash proceeds, subject to its agreement to repurchase the
securities at a later date for a fixed price reflecting a market rate of
interest. There is a risk that the counter party to a reverse repurchase
agreement will be unable or unwilling to complete the transaction as
scheduled, which may result in losses to a Fund. A Fund will invest the
proceeds received under a reverse repurchase agreement in accordance with
its investment objective and policies.
OPTIONS
A Fund may invest in the following types of options, which involve the risks
described under the caption "Special Risk Factors -- Options, Futures,
Forwards, Swaps and Other Derivative Transactions" in this Appendix:
OPTIONS ON FOREIGN CURRENCIES: A Fund may purchase and write options on
foreign currencies for hedging and non-hedging purposes in a manner similar
to that in which Futures Contracts on foreign currencies, or Forward
Contracts, will be utilized. For example, a decline in the dollar value of a
foreign currency in which portfolio securities are denominated will reduce
the dollar value of such securities, even if their value in the foreign
currency remains constant. In order to protect against such diminutions in
the value of portfolio securities, a Fund may purchase put options on the
foreign currency. If the value of the currency does decline, a Fund will
have the right to sell such currency for a fixed amount in dollars and will
thereby offset, in whole in part, the adverse effect on its portfolio which
otherwise would have resulted.
Conversely, where a rise in the dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing
the cost of such securities, a Fund may purchase call options thereon. The
purchase of such options could offset, at least partially, the effect of the
adverse movements in exchange rates. As in the case of other types of
options, however, the benefit to a Fund deriving from purchases of foreign
currency options will be reduced by the amount of the premium and related
transaction costs. In addition, where currency exchange rates do not move in
the direction or to the extent anticipated, a Fund could sustain losses on
transactions in foreign currency options which would require it to forego a
portion or all of the benefits of advantageous changes in such rates. A Fund
may write options on foreign currencies for the same types of hedging
purposes. For example, where a Fund anticipates a decline in the dollar
value of foreign-denominated securities due to adverse fluctuations in
exchange rates it could, instead of purchasing a put option, write a call
option on the relevant currency. If the expected decline occurs, the option
will most likely not be exercised, and the diminution in value of portfolio
securities will be offset by the amount of the premium received less related
transaction costs. As in the case of other types of options, therefore, the
writing of Options on Foreign Currencies will constitute only a partial
hedge.
Similarly, instead of purchasing a call option to hedge against an
anticipated increase in the dollar cost of securities to be acquired, a Fund
could write a put option on the relevant currency which, if rates move in
the manner projected, will expire unexercised and allow a Fund to hedge such
increased cost up to the amount of the premium. Foreign currency options
written by a Fund will generally be covered in a manner similar to the
covering of other types of options. As in the case of other types of
options, however, the writing of a foreign currency option will constitute
only a partial hedge up to the amount of the premium, and only if rates move
in the expected direction. If this does not occur, the option may be
exercised and a Fund would be required to purchase or sell the underlying
currency at a loss which may not be offset by the amount of the premium.
Through the writing of options on foreign currencies, a Fund also may be
required to forego all or a portion of the benefits which might otherwise
have been obtained from favorable movements in exchange rates. The use of
foreign currency options for non-hedging purposes, like the use of other
types of derivatives for such purposes, presents greater profit potential
but also significant risk of loss and could be considered speculative.
OPTIONS ON FUTURES CONTRACTS: A Fund also may purchase and write options to
buy or sell those Futures Contracts in which it may invest ("Options on
Futures Contracts") as described above under "Futures Contracts." Such
investment strategies will be used for hedging purposes and for non-hedging
purposes, subject to applicable law.
An Option on a Futures Contract provides the holder with the right to
enter into a "long" position in the underlying Futures Contract, in the case
of a call option, or a "short" position in the underlying Futures Contract,
in the case of a put option, at a fixed exercise price up to a stated
expiration date or, in the case of certain options, on such date. Upon
exercise of the option by the holder, the contract market clearinghouse
establishes a corresponding short position for the writer of the option, in
the case of a call option, or a corresponding long position in the case of a
put option. In the event that an option is exercised, the parties will be
subject to all the risks associated with the trading of Futures Contracts,
such as payment of initial and variation margin deposits. In addition, the
writer of an Option on a Futures Contract, unlike the holder, is subject to
initial and variation margin requirements on the option position.
A position in an Option on a Futures Contract may be terminated by the
purchaser or seller prior to expiration by effecting a closing purchase or
sale transaction, subject to the availability of a liquid secondary market,
which is the purchase or sale of an option of the same type (i.e., the same
exercise price and expiration date) as the option previously purchased or
sold. The difference between the premiums paid and received represents a
Fund's profit or loss on the transaction.
Options on Futures Contracts that are written or purchased by a Fund on
U.S. exchanges are traded on the same contract market as the underlying
Futures Contract, and, like Futures Contracts, are subject to regulation by
the Commodity Futures Trading Commission (the "CFTC") and the performance
guarantee of the exchange clearinghouse. In addition, Options on Futures
Contracts may be traded on foreign exchanges. A Fund may cover the writing
of call Options on Futures Contracts (a) through purchases of the underlying
Futures Contract, (b) through ownership of the instrument, or instruments
included in the index, underlying the Futures Contract, or (c) through the
holding of a call on the same Futures Contract and in the same principal
amount as the call written where the exercise price of the call held (i) is
equal to or less than the exercise price of the call written or (ii) is
greater than the exercise price of the call written if a Fund owns liquid
and unencumbered assets equal to the difference. A Fund may cover the
writing of put Options on Futures Contracts (a) through sales of the
underlying Futures Contract, (b) through the ownership of liquid and
unencumbered assets equal to the value of the security or index underlying
the Futures Contract, or (c) through the holding of a put on the same
Futures Contract and in the same principal amount as the put written where
the exercise price of the put held (i) is equal to or greater than the
exercise price of the put written or where the exercise price of the put
held (ii) is less than the exercise price of the put written if a Fund owns
liquid and unencumbered assets equal to the difference. Put and call Options
on Futures Contracts may also be covered in such other manner as may be in
accordance with the rules of the exchange on which the option is traded and
applicable laws and regulations. Upon the exercise of a call Option on a
Futures Contract written by a Fund, a Fund will be required to sell the
underlying Futures Contract which, if a Fund has covered its obligation
through the purchase of such Contract, will serve to liquidate its futures
position. Similarly, where a put Option on a Futures Contract written by a
Fund is exercised, a Fund will be required to purchase the underlying
Futures Contract which, if a Fund has covered its obligation through the
sale of such Contract, will close out its futures position.
The writing of a call option on a Futures Contract for hedging purposes
constitutes a partial hedge against declining prices of the securities or
other instruments required to be delivered under the terms of the Futures
Contract. If the futures price at expiration of the option is below the
exercise price, a Fund will retain the full amount of the option premium,
less related transaction costs, which provides a partial hedge against any
decline that may have occurred in a Fund's portfolio holdings. The writing
of a put option on a Futures Contract constitutes a partial hedge against
increasing prices of the securities or other instruments required to be
delivered under the terms of the Futures Contract. If the futures price at
expiration of the option is higher than the exercise price, a Fund will
retain the full amount of the option premium which provides a partial hedge
against any increase in the price of securities which a Fund intends to
purchase. If a put or call option a Fund has written is exercised, a Fund
will incur a loss which will be reduced by the amount of the premium it
receives. Depending on the degree of correlation between changes in the
value of its portfolio securities and the changes in the value of its
futures positions, a Fund's losses from existing Options on Futures
Contracts may to some extent be reduced or increased by changes in the value
of portfolio securities.
A Fund may purchase Options on Futures Contracts for hedging purposes
instead of purchasing or selling the underlying Futures Contracts. For
example, where a decrease in the value of portfolio securities is
anticipated as a result of a projected market-wide decline or changes in
interest or exchange rates, a Fund could, in lieu of selling Futures
Contracts, purchase put options thereon. In the event that such decrease
occurs, it may be offset, in whole or in part, by a profit on the option.
Conversely, where it is projected that the value of securities to be
acquired by a Fund will increase prior to acquisition, due to a market
advance or changes in interest or exchange rates, a Fund could purchase call
Options on Futures Contracts rather than purchasing the underlying Futures
Contracts.
OPTIONS ON SECURITIES: A Fund may write (sell) covered put and call options,
and purchase put and call options, on securities. Call and put options
written by a Fund may be covered in the manner set forth below.
A call option written by a Fund is "covered" if a Fund owns the security
underlying the call or has an absolute and immediate right to acquire that
security without additional cash consideration (or for additional cash
consideration if a Fund owns liquid and unencumbered assets equal to the
amount of cash consideration) upon conversion or exchange of other
securities held in its portfolio. A call option is also covered if a Fund
holds a call on the same security and in the same principal amount as the
call written where the exercise price of the call held (a) is equal to or
less than the exercise price of the call written or (b) is greater than the
exercise price of the call written if a Fund owns liquid and unencumbered
assets equal to the difference. A put option written by a Fund is "covered"
if a Fund owns liquid and unencumbered assets with a value equal to the
exercise price, or else holds a put on the same security and in the same
principal amount as the put written where the exercise price of the put held
is equal to or greater than the exercise price of the put written or where
the exercise price of the put held is less than the exercise price of the
put written if a Fund owns liquid and unencumbered assets equal to the
difference. Put and call options written by a Fund may also be covered in
such other manner as may be in accordance with the requirements of the
exchange on which, or the counterparty with which, the option is traded, and
applicable laws and regulations. If the writer's obligation is not so
covered, it is subject to the risk of the full change in value of the
underlying security from the time the option is written until exercise.
Effecting a closing transaction in the case of a written call option will
permit a Fund to write another call option on the underlying security with
either a different exercise price or expiration date or both, or in the case
of a written put option will permit a Fund to write another put option to
the extent that a Fund owns liquid and unencumbered assets. Such
transactions permit a Fund to generate additional premium income, which will
partially offset declines in the value of portfolio securities or increases
in the cost of securities to be acquired. Also, effecting a closing
transaction will permit the cash or proceeds from the concurrent sale of any
securities subject to the option to be used for other investments of a Fund,
provided that another option on such security is not written. If a Fund
desires to sell a particular security from its portfolio on which it has
written a call option, it will effect a closing transaction in connection
with the option prior to or concurrent with the sale of the security.
A Fund will realize a profit from a closing transaction if the premium
paid in connection with the closing of an option written by a Fund is less
than the premium received from writing the option, or if the premium
received in connection with the closing of an option purchased by a Fund is
more than the premium paid for the original purchase. Conversely, a Fund
will suffer a loss if the premium paid or received in connection with a
closing transaction is more or less, respectively, than the premium received
or paid in establishing the option position. Because increases in the market
price of a call option will generally reflect increases in the market price
of the underlying security, any loss resulting from the repurchase of a call
option previously written by a Fund is likely to be offset in whole or in
part by appreciation of the underlying security owned by a Fund.
A Fund may write options in connection with buy-and-write transactions;
that is, a Fund may purchase a security and then write a call option against
that security. The exercise price of the call option a Fund determines to
write will depend upon the expected price movement of the underlying
security. The exercise price of a call option may be below ("in-the-money"),
equal to ("at-the-money") or above ("out-of-the-money") the current value of
the underlying security at the time the option is written. Buy-and-write
transactions using in-the-money call options may be used when it is expected
that the price of the underlying security will decline moderately during the
option period. Buy-and-write transactions using out-of-the-money call
options may be used when it is expected that the premiums received from
writing the call option plus the appreciation in the market price of the
underlying security up to the exercise price will be greater than the
appreciation in the price of the underlying security alone. If the call
options are exercised in such transactions, a Fund's maximum gain will be
the premium received by it for writing the option, adjusted upwards or
downwards by the difference between a Fund's purchase price of the security
and the exercise price, less related transaction costs. If the options are
not exercised and the price of the underlying security declines, the amount
of such decline will be offset in part, or entirely, by the premium
received.
The writing of covered put options is similar in terms of risk/return
characteristics to buy-and-write transactions. If the market price of the
underlying security rises or otherwise is above the exercise price, the put
option will expire worthless and a Fund's gain will be limited to the
premium received, less related transaction costs. If the market price of the
underlying security declines or otherwise is below the exercise price, a
Fund may elect to close the position or retain the option until it is
exercised, at which time a Fund will be required to take delivery of the
security at the exercise price; a Fund's return will be the premium received
from the put option minus the amount by which the market price of the
security is below the exercise price, which could result in a loss.
Out-of-the-money, at-the-money and in-the-money put options may be used by a
Fund in the same market environments that call options are used in
equivalent buy-and-write transactions.
A Fund may also write combinations of put and call options on the same
security, known as "straddles" with the same exercise price and expiration
date. By writing a straddle, a Fund undertakes a simultaneous obligation to
sell and purchase the same security in the event that one of the options is
exercised. If the price of the security subsequently rises sufficiently
above the exercise price to cover the amount of the premium and transaction
costs, the call will likely be exercised and a Fund will be required to sell
the underlying security at a below market price. This loss may be offset,
however, in whole or part, by the premiums received on the writing of the
two options. Conversely, if the price of the security declines by a
sufficient amount, the put will likely be exercised. The writing of
straddles will likely be effective, therefore, only where the price of the
security remains stable and neither the call nor the put is exercised. In
those instances where one of the options is exercised, the loss on the
purchase or sale of the underlying security may exceed the amount of the
premiums received.
By writing a call option, a Fund limits its opportunity to profit from any
increase in the market value of the underlying security above the exercise
price of the option. By writing a put option, a Fund assumes the risk that
it may be required to purchase the underlying security for an exercise price
above its then-current market value, resulting in a capital loss unless the
security subsequently appreciates in value. The writing of options on
securities will not be undertaken by a Fund solely for hedging purposes, and
could involve certain risks which are not present in the case of hedging
transactions. Moreover, even where options are written for hedging purposes,
such transactions constitute only a partial hedge against declines in the
value of portfolio securities or against increases in the value of
securities to be acquired, up to the amount of the premium.
A Fund may also purchase options for hedging purposes or to increase its
return. Put options may be purchased to hedge against a decline in the value
of portfolio securities. If such decline occurs, the put options will permit
a Fund to sell the securities at the exercise price, or to close out the
options at a profit. By using put options in this way, a Fund will reduce
any profit it might otherwise have realized in the underlying security by
the amount of the premium paid for the put option and by transaction costs.
A Fund may also purchase call options to hedge against an increase in the
price of securities that a Fund anticipates purchasing in the future. If
such increase occurs, the call option will permit a Fund to purchase the
securities at the exercise price, or to close out the options at a profit.
The premium paid for the call option plus any transaction costs will reduce
the benefit, if any, realized by a Fund upon exercise of the option, and,
unless the price of the underlying security rises sufficiently, the option
may expire worthless to a Fund.
OPTIONS ON STOCK INDICES: A Fund may write (sell) covered call and put
options and purchase call and put options on stock indices. In contrast to
an option on a security, an option on a stock index provides the holder with
the right but not the obligation to make or receive a cash settlement upon
exercise of the option, rather than the right to purchase or sell a
security. The amount of this settlement is generally equal to (i) the
amount, if any, by which the fixed exercise price of the option exceeds (in
the case of a call) or is below (in the case of a put) the closing value of
the underlying index on the date of exercise, multiplied by (ii) a fixed
"index multiplier." A Fund may cover written call options on stock indices
by owning securities whose price changes, in the opinion of the Adviser or
Sub-Adviser, are expected to be similar to those of the underlying index, or
by having an absolute and immediate right to acquire such securities without
additional cash consideration (or for additional cash consideration if a
Fund owns liquid and unencumbered assets equal to the amount of cash
consideration) upon conversion or exchange of other securities in its
portfolio. Where a Fund covers a call option on a stock index through
ownership of securities, such securities may not match the composition of
the index and, in that event, a Fund will not be fully covered and could be
subject to risk of loss in the event of adverse changes in the value of the
index. A Fund may also cover call options on stock indices by holding a call
on the same index and in the same principal amount as the call written where
the exercise price of the call held (a) is equal to or less than the
exercise price of the call written or (b) is greater than the exercise price
of the call written if a Fund owns liquid and unencumbered assets equal to
the difference. A Fund may cover put options on stock indices by owning
liquid and unencumbered assets with a value equal to the exercise price, or
by holding a put on the same stock index and in the same principal amount as
the put written where the exercise price of the put held (a) is equal to or
greater than the exercise price of the put written or (b) is less than the
exercise price of the put written if a Fund owns liquid and unencumbered
assets equal to the difference. Put and call options on stock indices may
also be covered in such other manner as may be in accordance with the rules
of the exchange on which, or the counterparty with which, the option is
traded and applicable laws and regulations.
A Fund will receive a premium from writing a put or call option, which
increases a Fund's gross income in the event the option expires unexercised
or is closed out at a profit. If the value of an index on which a Fund has
written a call option falls or remains the same, a Fund will realize a
profit in the form of the premium received (less transaction costs) that
could offset all or a portion of any decline in the value of the securities
it owns. If the value of the index rises, however, a Fund will realize a
loss in its call option position, which will reduce the benefit of any
unrealized appreciation in a Fund's stock investments. By writing a put
option, a Fund assumes the risk of a decline in the index. To the extent
that the price changes of securities owned by a Fund correlate with changes
in the value of the index, writing covered put options on indices will
increase a Fund's losses in the event of a market decline, although such
losses will be offset in part by the premium received for writing the
option.
A Fund may also purchase put options on stock indices to hedge its
investments against a decline in value. By purchasing a put option on a
stock index, a Fund will seek to offset a decline in the value of securities
it owns through appreciation of the put option. If the value of a Fund's
investments does not decline as anticipated, or if the value of the option
does not increase, a Fund's loss will be limited to the premium paid for the
option plus related transaction costs. The success of this strategy will
largely depend on the accuracy of the correlation between the changes in
value of the index and the changes in value of a Fund's security holdings.
The purchase of call options on stock indices may be used by a Fund to
attempt to reduce the risk of missing a broad market advance, or an advance
in an industry or market segment, at a time when a Fund holds uninvested
cash or short-term debt securities awaiting investment. When purchasing call
options for this purpose, a Fund will also bear the risk of losing all or a
portion of the premium paid if the value of the index does not rise. The
purchase of call options on stock indices when a Fund is substantially fully
invested is a form of leverage, up to the amount of the premium and related
transaction costs, and involves risks of loss and of increased volatility
similar to those involved in purchasing calls on securities a Fund owns.
The index underlying a stock index option may be a "broad-based" index,
such as the Standard & Poor's 500 Index or the New York Stock Exchange
Composite Index, the changes in value of which ordinarily will reflect
movements in the stock market in general. In contrast, certain options may
be based on narrower market indices, such as the Standard & Poor's 100
Index, or on indices of securities of particular industry groups, such as
those of oil and gas or technology companies. A stock index assigns relative
values to the stocks included in the index and the index fluctuates with
changes in the market values of the stocks so included. The composition of
the index is changed periodically.
RESET OPTIONS:
In certain instances, a Fund may purchase or write options on U.S. Treasury
securities which provide for periodic adjustment of the strike price and may
also provide for the periodic adjustment of the premium during the term of
each such option. Like other types of options, these transactions, which may
be referred to as "reset" options or "adjustable strike" options grant the
purchaser the right to purchase (in the case of a call) or sell (in the case
of a put), a specified type of U.S. Treasury security at any time up to a
stated expiration date (or, in certain instances, on such date). In contrast
to other types of options, however, the price at which the underlying
security may be purchased or sold under a "reset" option is determined at
various intervals during the term of the option, and such price fluctuates
from interval to interval based on changes in the market value of the
underlying security. As a result, the strike price of a "reset" option, at
the time of exercise, may be less advantageous than if the strike price had
been fixed at the initiation of the option. In addition, the premium paid
for the purchase of the option may be determined at the termination, rather
than the initiation, of the option. If the premium for a reset option
written by a Fund is paid at termination, a Fund assumes the risk that (i)
the premium may be less than the premium which would otherwise have been
received at the initiation of the option because of such factors as the
volatility in yield of the underlying Treasury security over the term of the
option and adjustments made to the strike price of the option, and (ii) the
option purchaser may default on its obligation to pay the premium at the
termination of the option. Conversely, where a Fund purchases a reset
option, it could be required to pay a higher premium than would have been
the case at the initiation of the option.
"YIELD CURVE" OPTIONS: A Fund may also enter into options on the "spread,"
or yield differential, between two fixed income securities, in transactions
referred to as "yield curve" options. In contrast to other types of options,
a yield curve option is based on the difference between the yields of
designated securities, rather than the prices of the individual securities,
and is settled through cash payments. Accordingly, a yield curve option is
profitable to the holder if this differential widens (in the case of a call)
or narrows (in the case of a put), regardless of whether the yields of the
underlying securities increase or decrease.
Yield curve options may be used for the same purposes as other options on
securities. Specifically, a Fund may purchase or write such options for
hedging purposes. For example, a Fund may purchase a call option on the
yield spread between two securities, if it owns one of the securities and
anticipates purchasing the other security and wants to hedge against an
adverse change in the yield spread between the two securities. A Fund may
also purchase or write yield curve options for other than hedging purposes
(i.e., in an effort to increase its current income) if, in the judgment of
the Adviser or Sub-Adviser, a Fund will be able to profit from movements in
the spread between the yields of the underlying securities. The trading of
yield curve options is subject to all of the risks associated with the
trading of other types of options. In addition, however, such options
present risk of loss even if the yield of one of the underlying securities
remains constant, if the spread moves in a direction or to an extent which
was not anticipated. Yield curve options written by a Fund will be
"covered". A call (or put) option is covered if a Fund holds another call
(or put) option on the spread between the same two securities and owns
liquid and unencumbered assets sufficient to cover a Fund's net liability
under the two options. Therefore, a Fund's liability for such a covered
option is generally limited to the difference between the amount of a Fund's
liability under the option written by a Fund less the value of the option
held by a Fund. Yield curve options may also be covered in such other manner
as may be in accordance with the requirements of the counterparty with which
the option is traded and applicable laws and regulations. Yield curve
options are traded over-the-counter and because they have been only recently
introduced, established trading markets for these securities have not yet
developed.
REPURCHASE AGREEMENTS
A Fund may enter into repurchase agreements with sellers who are member
firms (or a subsidiary thereof) of the New York Stock Exchange or members of
the Federal Reserve System, recognized primary U.S. Government securities
dealers or institutions which the Adviser has determined to be of comparable
creditworthiness. The securities that a Fund purchases and holds through its
agent are U.S. Government securities, the values of which are equal to or
greater than the repurchase price agreed to be paid by the seller. The
repurchase price may be higher than the purchase price, the difference being
income to a Fund, or the purchase and repurchase prices may be the same,
with interest at a standard rate due to a Fund together with the repurchase
price on repurchase. In either case, the income to a Fund is unrelated to
the interest rate on the Government securities.
The repurchase agreement provides that in the event the seller fails to
pay the amount agreed upon on the agreed upon delivery date or upon demand,
as the case may be, a Fund will have the right to liquidate the securities.
If at the time a Fund is contractually entitled to exercise its right to
liquidate the securities, the seller is subject to a proceeding under the
bankruptcy laws or its assets are otherwise subject to a stay order, a
Fund's exercise of its right to liquidate the securities may be delayed and
result in certain losses and costs to a Fund. A Fund has adopted and follows
procedures which are intended to minimize the risks of repurchase
agreements. For example, a Fund only enters into repurchase agreements after
the Adviser or Sub-Adviser has determined that the seller is creditworthy,
and the Adviser or Sub-Adviser monitors that seller's creditworthiness on an
ongoing basis. Moreover, under such agreements, the value of the securities
(which are marked to market every business day) is required to be greater
than the repurchase price, and a Fund has the right to make margin calls at
any time if the value of the securities falls below the agreed upon
collateral.
RESTRICTED SECURITIES
A Fund may purchase securities that are not registered under the Securities
Act of 1933, as amended ("1933 Act") ("restricted securities"), including
those that can be offered and sold to "qualified institutional buyers" under
Rule 144A under the 1933 Act ("Rule 144A securities") and commercial paper
issued under Section 4(2) of the 1933 Act ("4(2) Paper"). A determination is
made, based upon a continuing review of the trading markets for the Rule
144A security or 4(2) Paper, whether such security is liquid and thus not
subject to a Fund's limitation on investing in illiquid investments. The
Board of Trustees has adopted guidelines and delegated to MFS the daily
function of determining and monitoring the liquidity of Rule 144A securities
and 4(2) Paper. The Board, however, retains oversight of the liquidity
determinations focusing on factors such as valuation, liquidity and
availability of information. Investing in Rule 144A securities could have
the effect of decreasing the level of liquidity in a Fund to the extent that
qualified institutional buyers become for a time uninterested in purchasing
these Rule 144A securities held in a Fund's portfolio. Subject to a Fund's
limitation on investments in illiquid investments, a Fund may also invest in
restricted securities that may not be sold under Rule 144A, which presents
certain risks. As a result, a Fund might not be able to sell these
securities when the Adviser or Sub-Adviser wishes to do so, or might have to
sell them at less than fair value. In addition, market quotations are less
readily available. Therefore, judgment may at times play a greater role in
valuing these securities than in the case of unrestricted securities.
SHORT SALES
A Fund may seek to hedge investments or realize additional gains through
short sales. A Fund may make short sales, which are transactions in which a
Fund sells a security it does not own, in anticipation of a decline in the
market value of that security. To complete such a transaction, a Fund must
borrow the security to make delivery to the buyer. A Fund then is obligated
to replace the security borrowed by purchasing it at the market price at the
time of replacement. The price at such time may be more or less than the
price at which the security was sold by a Fund. Until the security is
replaced, a Fund is required to repay the lender any dividends or interest
which accrue during the period of the loan. To borrow the security, a Fund
also may be required to pay a premium, which would increase the cost of the
security sold. The net proceeds of the short sale will be retained by the
broker, to the extent necessary to meet margin requirements, until the short
position is closed out. A Fund also will incur transaction costs in
effecting short sales.
A Fund will incur a loss as a result of the short sale if the price of the
security increases between the date of the short sale and the date on which
a Fund replaces the borrowed security. A Fund will realize a gain if the
price of the security declines between those dates. The amount of any gain
will be decreased, and the amount of any loss increased, by the amount of
the premium, dividends or interest a Fund may be required to pay in
connection with a short sale.
Whenever a Fund engages in short sales, it identifies liquid and
unencumbered assets in an amount that, when combined with the amount of
collateral deposited with the broker connection with the short sale, equals
the current market value of the security sold short.
SHORT SALES AGAINST THE BOX
A Fund may make short sales "against the box," i.e., when a security
identical to one owned by a Fund is borrowed and sold short. If a Fund
enters into a short sale against the box, it is required to segregate
securities equivalent in kind and amount to the securities sold short (or
securities convertible or exchangeable into such securities) and is required
to hold such securities while the short sale is outstanding. A Fund will
incur transaction costs, including interest, in connection with opening,
maintaining, and closing short sales against the box.
SHORT TERM INSTRUMENTS
A Fund may hold cash and invest in cash equivalents, such as short-term U.S.
Government Securities, commercial paper and bank instruments.
SWAPS AND RELATED DERIVATIVE INSTRUMENTS
A Fund may enter into interest rate swaps, currency swaps and other types of
available swap agreements, including swaps on securities, commodities and
indices, and related types of derivatives, such as caps, collars and floors.
A swap is an agreement between two parties pursuant to which each party
agrees to make one or more payments to the other on regularly scheduled
dates over a stated term, based on different interest rates, currency
exchange rates, security or commodity prices, the prices or rates of other
types of financial instruments or assets or the levels of specified indices.
Under a typical swap, one party may agree to pay a fixed rate or a floating
rate determined by reference to a specified instrument, rate or index,
multiplied in each case by a specified amount (the "notional amount"), while
the other party agrees to pay an amount equal to a different floating rate
multiplied by the same notional amount. On each payment date, the
obligations of parties are netted, with only the net amount paid by one
party to the other. All swap agreements entered into by a Fund with the same
counterparty are generally governed by a single master agreement, which
provides for the netting of all amounts owed by the parties under the
agreement upon the occurrence of an event of default, thereby reducing the
credit risk to which such party is exposed.
Swap agreements are typically individually negotiated and structured to
provide exposure to a variety of different types of investments or market
factors. Swap agreements may be entered into for hedging or non-hedging
purposes and therefore may increase or decrease a Fund's exposure to the
underlying instrument, rate, asset or index. Swap agreements can take many
different forms and are known by a variety of names. A Fund is not limited
to any particular form or variety of swap agreement if the Adviser
determines it is consistent with a Fund's investment objective and policies.
For example, a Fund may enter into an interest rate swap in order to
protect against declines in the value of fixed income securities held by a
Fund. In such an instance, a Fund would agree with a counterparty to pay a
fixed rate (multiplied by a notional amount) and the counterparty would
agree to pay a floating rate multiplied by the same notional amount. If
interest rates rise, resulting in a diminution in the value of a Fund's
portfolio, a Fund would receive payments under the swap that would offset,
in whole or part, such diminution in value. A Fund may also enter into swaps
to modify its exposure to particular markets or instruments, such as a
currency swap between the U.S. dollar and another currency which would have
the effect of increasing or decreasing a Fund's exposure to each such
currency. A Fund might also enter into a swap on a particular security, or a
basket or index of securities, in order to gain exposure to the underlying
security or securities, as an alternative to purchasing such securities.
Such transactions could be more efficient or less costly in certain
instances than an actual purchase or sale of the securities.
A Fund may enter into other related types of over-the-counter derivatives,
such as "caps", "floors", "collars" and options on swaps, or "swaptions",
for the same types of hedging or non-hedging purposes. Caps and floors are
similar to swaps, except that one party pays a fee at the time the
transaction is entered into and has no further payment obligations, while
the other party is obligated to pay an amount equal to the amount by which a
specified fixed or floating rate exceeds or is below another rate
(multiplied by a notional amount). Caps and floors, therefore, are also
similar to options. A collar is in effect a combination of a cap and a
floor, with payments made only within or outside a specified range of prices
or rates. A swaption is an option to enter into a swap agreement. Like other
types of options, the buyer of a swaption pays a non-refundable premium for
the option and obtains the right, but not the obligation, to enter into the
underlying swap on the agreed-upon terms.
A Fund will maintain liquid and unencumbered assets to cover its current
obligations under swap and other over-the-counter derivative transactions.
If a Fund enters into a swap agreement on a net basis (i.e., the two payment
streams are netted out, with a Fund receiving or paying, as the case may be,
only the net amount of the two payments), a Fund will maintain liquid and
unencumbered assets with a daily value at least equal to the excess, if any,
of a Fund's accrued obligations under the swap agreement over the accrued
amount a Fund is entitled to receive under the agreement. If a Fund enters
into a swap agreement on other than a net basis, it will maintain liquid and
unencumbered assets with a value equal to the full amount of a Fund's
accrued obligations under the agreement.
The most significant factor in the performance of swaps, caps, floors and
collars is the change in the underlying price, rate or index level that
determines the amount of payments to be made under the arrangement. If the
Adviser is incorrect in its forecasts of such factors, the investment
performance of a Fund would be less than what it would have been if these
investment techniques had not been used. If a swap agreement calls for
payments by a Fund, a Fund must be prepared to make such payments when due.
In addition, if the counterparty's creditworthiness would decline, the value
of the swap agreement would be likely to decline, potentially resulting in
losses.
If the counterparty defaults, a Fund's risk of loss consists of the net
amount of payments that a Fund is contractually entitled to receive. A Fund
anticipates that it will be able to eliminate or reduce its exposure under
these arrangements by assignment or other disposition or by entering into an
offsetting agreement with the same or another counterparty, but there can be
no assurance that it will be able to do so.
The uses by a Fund of swaps and related derivative instruments also
involves the risks described under the caption "Special Risk Factors --
Options, Futures, Forwards, Swaps and Other Derivative Transactions" in
this Appendix.
TEMPORARY BORROWINGS
A Fund may borrow money for temporary purposes (e.g., to meet redemption
requests or settle outstanding purchases of portfolio securities).
TEMPORARY DEFENSIVE POSITIONS
During periods of unusual market conditions when the Adviser or Sub-Adviser
believes that investing for temporary defensive purposes is appropriate, or
in order to meet anticipated redemption requests, a large portion or all of
the assets of a Fund may be invested in cash (including foreign currency) or
cash equivalents, including, but not limited to, obligations of banks
(including certificates of deposit, bankers' acceptances, time deposits and
repurchase agreements), commercial paper, short-term notes, U.S. Government
Securities and related repurchase agreements.
WARRANTS
A Fund may invest in warrants. Warrants are securities that give a Fund the
right to purchase equity securities from the issuer at a specific price (the
"strike price") for a limited period of time. The strike price of warrants
typically is much lower than the current market price of the underlying
securities, yet they are subject to similar price fluctuations. As a result,
warrants may be more volatile investments than the underlying securities and
may offer greater potential for capital appreciation as well as capital
loss. Warrants do not entitle a holder to dividends or voting rights with
respect to the underlying securities and do not represent any rights in the
assets of the issuing company. Also, the value of the warrant does not
necessarily change with the value of the underlying securities and a warrant
ceases to have value if it is not exercised prior to the expiration date.
These factors can make warrants more speculative than other types of
investments.
"WHEN-ISSUED" SECURITIES
A Fund may purchase securities on a "when-issued" or on a "forward delivery"
basis which means that the securities will be delivered to a Fund at a
future date usually beyond customary settlement time. The commitment to
purchase a security for which payment will be made on a future date may be
deemed a separate security. In general, a Fund does not pay for such
securities until received, and does not start earning interest on the
securities until the contractual settlement date. While awaiting delivery of
securities purchased on such bases, a Fund will identify liquid and
unencumbered assets equal to its forward delivery commitment.
SPECIAL RISK FACTORS -- OPTIONS, FUTURES, FORWARDS, SWAPS AND OTHER
DERIVATIVE TRANSACTIONS
RISK OF IMPERFECT CORRELATION OF HEDGING INSTRUMENTS WITH A FUND'S
PORTFOLIO: A Fund's ability effectively to hedge all or a portion of its
portfolio through transactions in derivatives, including options, Futures
Contracts, Options on Futures Contracts, Forward Contracts, swaps and other
types of derivatives depends on the degree to which price movements in the
underlying index or instrument correlate with price movements in the
relevant portion of a Fund's portfolio. In the case of derivative
instruments based on an index, the portfolio will not duplicate the
components of the index, and in the case of derivative instruments on fixed
income securities, the portfolio securities which are being hedged may not
be the same type of obligation underlying such derivatives. The use of
derivatives for "cross hedging" purposes (such as a transaction in a Forward
Contract on one currency to hedge exposure to a different currency) may
involve greater correlation risks. Consequently, a Fund bears the risk that
the price of the portfolio securities being hedged will not move in the same
amount or direction as the underlying index or obligation.
If a Fund purchases a put option on an index and the index decreases less
than the value of the hedged securities, a Fund would experience a loss
which is not completely offset by the put option. It is also possible that
there may be a negative correlation between the index or obligation
underlying an option or Futures Contract in which a Fund has a position and
the portfolio securities a Fund is attempting to hedge, which could result
in a loss on both the portfolio and the hedging instrument. It should be
noted that stock index futures contracts or options based upon a narrower
index of securities, such as those of a particular industry group, may
present greater risk than options or futures based on a broad market index.
This is due to the fact that a narrower index is more susceptible to rapid
and extreme fluctuations as a result of changes in the value of a small
number of securities. Nevertheless, where a Fund enters into transactions in
options or futures on narrowly-based indices for hedging purposes, movements
in the value of the index should, if the hedge is successful, correlate
closely with the portion of a Fund's portfolio or the intended acquisitions
being hedged.
The trading of derivatives for hedging purposes entails the additional
risk of imperfect correlation between movements in the price of the
derivative and the price of the underlying index or obligation. The
anticipated spread between the prices may be distorted due to the
differences in the nature of the markets such as differences in margin
requirements, the liquidity of such markets and the participation of
speculators in the derivatives markets. In this regard, trading by
speculators in derivatives has in the past occasionally resulted in market
distortions, which may be difficult or impossible to predict, particularly
near the expiration of such instruments.
The trading of Options on Futures Contracts also entails the risk that
changes in the value of the underlying Futures Contracts will not be fully
reflected in the value of the option. The risk of imperfect correlation,
however, generally tends to diminish as the maturity date of the Futures
Contract or expiration date of the option approaches.
Further, with respect to options on securities, options on stock indices,
options on currencies and Options on Futures Contracts, a Fund is subject to
the risk of market movements between the time that the option is exercised
and the time of performance thereunder. This could increase the extent of
any loss suffered by a Fund in connection with such transactions.
In writing a covered call option on a security, index or futures contract,
a Fund also incurs the risk that changes in the value of the instruments
used to cover the position will not correlate closely with changes in the
value of the option or underlying index or instrument. For example, where a
Fund covers a call option written on a stock index through segregation of
securities, such securities may not match the composition of the index, and
a Fund may not be fully covered. As a result, a Fund could be subject to
risk of loss in the event of adverse market movements.
The writing of options on securities, options on stock indices or Options
on Futures Contracts constitutes only a partial hedge against fluctuations
in the value of a Fund's portfolio. When a Fund writes an option, it will
receive premium income in return for the holder's purchase of the right to
acquire or dispose of the underlying obligation. In the event that the price
of such obligation does not rise sufficiently above the exercise price of
the option, in the case of a call, or fall below the exercise price, in the
case of a put, the option will not be exercised and a Fund will retain the
amount of the premium, less related transaction costs, which will constitute
a partial hedge against any decline that may have occurred in a Fund's
portfolio holdings or any increase in the cost of the instruments to be
acquired.
Where the price of the underlying obligation moves sufficiently in favor
of the holder to warrant exercise of the option, however, and the option is
exercised, a Fund will incur a loss which may only be partially offset by
the amount of the premium it received. Moreover, by writing an option, a
Fund may be required to forego the benefits which might otherwise have been
obtained from an increase in the value of portfolio securities or other
assets or a decline in the value of securities or assets to be acquired. In
the event of the occurrence of any of the foregoing adverse market events, a
Fund's overall return may be lower than if it had not engaged in the hedging
transactions. Furthermore, the cost of using these techniques may make it
economically infeasible for a Fund to engage in such transactions.
RISKS OF NON-HEDGING TRANSACTIONS: A Fund may enter transactions in
derivatives for non-hedging purposes as well as hedging purposes.
Non-hedging transactions in such instruments involve greater risks and may
result in losses which may not be offset by increases in the value of
portfolio securities or declines in the cost of securities to be acquired. A
Fund will only write covered options, such that liquid and unencumbered
assets necessary to satisfy an option exercise will be identified, unless
the option is covered in such other manner as may be in accordance with the
rules of the exchange on which, or the counterparty with which, the option
is traded and applicable laws and regulations. Nevertheless, the method of
covering an option employed by a Fund may not fully protect it against risk
of loss and, in any event, a Fund could suffer losses on the option position
which might not be offset by corresponding portfolio gains. A Fund may also
enter into futures, Forward Contracts or swaps for non-hedging purposes. For
example, a Fund may enter into such a transaction as an alternative to
purchasing or selling the underlying instrument or to obtain desired
exposure to an index or market. In such instances, a Fund will be exposed to
the same economic risks incurred in purchasing or selling the underlying
instrument or instruments. However, transactions in futures, Forward
Contracts or swaps may be leveraged, which could expose a Fund to greater
risk of loss than such purchases or sales. Entering into transactions in
derivatives for other than hedging purposes, therefore, could expose a Fund
to significant risk of loss if the prices, rates or values of the underlying
instruments or indices do not move in the direction or to the extent
anticipated.
With respect to the writing of straddles on securities, a Fund incurs the
risk that the price of the underlying security will not remain stable, that
one of the options written will be exercised and that the resulting loss
will not be offset by the amount of the premiums received. Such
transactions, therefore, create an opportunity for increased return by
providing a Fund with two simultaneous premiums on the same security, but
involve additional risk, since a Fund may have an option exercised against
it regardless of whether the price of the security increases or decreases.
RISK OF A POTENTIAL LACK OF A LIQUID SECONDARY MARKET: Prior to exercise or
expiration, a futures or option position can only be terminated by entering
into a closing purchase or sale transaction. This requires a secondary
market for such instruments on the exchange on which the initial transaction
was entered into. While a Fund will enter into options or futures positions
only if there appears to be a liquid secondary market therefor, there can be
no assurance that such a market will exist for any particular contract at
any specific time. In that event, it may not be possible to close out a
position held by a Fund, and a Fund could be required to purchase or sell
the instrument underlying an option, make or receive a cash settlement or
meet ongoing variation margin requirements. Under such circumstances, if a
Fund has insufficient cash available to meet margin requirements, it will be
necessary to liquidate portfolio securities or other assets at a time when
it is disadvantageous to do so. The inability to close out options and
futures positions, therefore, could have an adverse impact on a Fund's
ability effectively to hedge its portfolio, and could result in trading
losses.
The liquidity of a secondary market in a Futures Contract or option
thereon may be adversely affected by "daily price fluctuation limits,"
established by exchanges, which limit the amount of fluctuation in the price
of a contract during a single trading day. Once the daily limit has been
reached in the contract, no trades may be entered into at a price beyond the
limit, thus preventing the liquidation of open futures or option positions
and requiring traders to make additional margin deposits. Prices have in the
past moved to the daily limit on a number of consecutive trading days.
The trading of Futures Contracts and options is also subject to the risk
of trading halts, suspensions, exchange or clearinghouse equipment failures,
government intervention, insolvency of a brokerage firm or clearinghouse or
other disruptions of normal trading activity, which could at times make it
difficult or impossible to liquidate existing positions or to recover excess
variation margin payments.
MARGIN: Because of low initial margin deposits made upon the establishment
of a futures, forward or swap position (certain of which may require no
initial margin deposits) and the writing of an option, such transactions
involve substantial leverage. As a result, relatively small movements in the
price of the contract can result in substantial unrealized gains or losses.
Where a Fund enters into such transactions for hedging purposes, any losses
incurred in connection therewith should, if the hedging strategy is
successful, be offset, in whole or in part, by increases in the value of
securities or other assets held by a Fund or decreases in the prices of
securities or other assets a Fund intends to acquire. Where a Fund enters
into such transactions for other than hedging purposes, the margin
requirements associated with such transactions could expose a Fund to
greater risk.
POTENTIAL BANKRUPTCY OF A CLEARINGHOUSE OR BROKER: When a Fund enters into
transactions in exchange-traded futures or options, it is exposed to the
risk of the potential bankruptcy of the relevant exchange clearinghouse or
the broker through which a Fund has effected the transaction. In that event,
a Fund might not be able to recover amounts deposited as margin, or amounts
owed to a Fund in connection with its transactions, for an indefinite period
of time, and could sustain losses of a portion or all of such amounts.
Moreover, the performance guarantee of an exchange clearinghouse generally
extends only to its members and a Fund could sustain losses, notwithstanding
such guarantee, in the event of the bankruptcy of its broker.
TRADING AND POSITION LIMITS: The exchanges on which futures and options are
traded may impose limitations governing the maximum number of positions on
the same side of the market and involving the same underlying instrument
which may be held by a single investor, whether acting alone or in concert
with others (regardless of whether such contracts are held on the same or
different exchanges or held or written in one or more accounts or through
one or more brokers). Further, the CFTC and the various contract markets
have established limits referred to as "speculative position limits" on the
maximum net long or net short position which any person may hold or control
in a particular futures or option contract. An exchange may order the
liquidation of positions found to be in violation of these limits and it may
impose other sanctions or restrictions. The Adviser and Sub-Adviser do not
believe that these trading and position limits will have any adverse impact
on the strategies for hedging the portfolios of a Fund.
RISKS OF OPTIONS ON FUTURES CONTRACTS: The amount of risk a Fund assumes
when it purchases an Option on a Futures Contract is the premium paid for
the option, plus related transaction costs. In order to profit from an
option purchased, however, it may be necessary to exercise the option and to
liquidate the underlying Futures Contract, subject to the risks of the
availability of a liquid offset market described herein. The writer of an
Option on a Futures Contract is subject to the risks of commodity futures
trading, including the requirement of initial and variation margin payments,
as well as the additional risk that movements in the price of the option may
not correlate with movements in the price of the underlying security, index,
currency or Futures Contract.
RISKS OF TRANSACTIONS IN FOREIGN CURRENCIES AND OVER-THE-COUNTER DERIVATIVES
AND OTHER TRANSACTIONS NOT CONDUCTED ON U.S. EXCHANGES: Transactions in
Forward Contracts on foreign currencies, as well as futures and options on
foreign currencies and transactions executed on foreign exchanges, are
subject to all of the correlation, liquidity and other risks outlined above.
In addition, however, such transactions are subject to the risk of
governmental actions affecting trading in or the prices of currencies
underlying such contracts, which could restrict or eliminate trading and
could have a substantial adverse effect on the value of positions held by a
Fund. Further, the value of such positions could be adversely affected by a
number of other complex political and economic factors applicable to the
countries issuing the underlying currencies.
Further, unlike trading in most other types of instruments, there is no
systematic reporting of last sale information with respect to the foreign
currencies underlying contracts thereon. As a result, the available
information on which trading systems will be based may not be as complete as
the comparable data on which a Fund makes investment and trading decisions
in connection with other transactions. Moreover, because the foreign
currency market is a global, 24-hour market, events could occur in that
market which will not be reflected in the forward, futures or options market
until the following day, thereby making it more difficult for a Fund to
respond to such events in a timely manner.
Settlements of exercises of over-the-counter Forward Contracts or foreign
currency options generally must occur within the country issuing the
underlying currency, which in turn requires traders to accept or make
delivery of such currencies in conformity with any U.S. or foreign
restrictions and regulations regarding the maintenance of foreign banking
relationships, fees, taxes or other charges.
Unlike transactions entered into by a Fund in Futures Contracts and
exchange-traded options, options on foreign currencies, Forward Contracts,
over-the-counter options on securities, swaps and other over-the-counter
derivatives are not traded on contract markets regulated by the CFTC or
(with the exception of certain foreign currency options) the SEC. To the
contrary, such instruments are traded through financial institutions acting
as market-makers, although foreign currency options are also traded on
certain national securities exchanges, such as the Philadelphia Stock
Exchange and the Chicago Board Options Exchange, subject to SEC regulation.
In an over-the-counter trading environment, many of the protections afforded
to exchange participants will not be available. For example, there are no
daily price fluctuation limits, and adverse market movements could therefore
continue to an unlimited extent over a period of time. Although the
purchaser of an option cannot lose more than the amount of the premium plus
related transaction costs, this entire amount could be lost. Moreover, the
option writer and a trader of Forward Contracts could lose amounts
substantially in excess of their initial investments, due to the margin and
collateral requirements associated with such positions.
In addition, over-the-counter transactions can only be entered into with a
financial institution willing to take the opposite side, as principal, of a
Fund's position unless the institution acts as broker and is able to find
another counterparty willing to enter into the transaction with a Fund.
Where no such counterparty is available, it will not be possible to enter
into a desired transaction. There also may be no liquid secondary market in
the trading of over-the-counter contracts, and a Fund could be required to
retain options purchased or written, or Forward Contracts or swaps entered
into, until exercise, expiration or maturity. This in turn could limit a
Fund's ability to profit from open positions or to reduce losses
experienced, and could result in greater losses.
Further, over-the-counter transactions are not subject to the guarantee of
an exchange clearinghouse, and a Fund will therefore be subject to the risk
of default by, or the bankruptcy of, the financial institution serving as
its counterparty. One or more of such institutions also may decide to
discontinue their role as market-makers in a particular currency or
security, thereby restricting a Fund's ability to enter into desired hedging
transactions. A Fund will enter into an over-the-counter transaction only
with parties whose creditworthiness has been reviewed and found satisfactory
by the Adviser.
Options on securities, options on stock indices, Futures Contracts,
Options on Futures Contracts and options on foreign currencies may be traded
on exchanges located in foreign countries. Such transactions may not be
conducted in the same manner as those entered into on U.S. exchanges, and
may be subject to different margin, exercise, settlement or expiration
procedures. As a result, many of the risks of over-the-counter trading may
be present in connection with such transactions.
Options on foreign currencies traded on national securities exchanges are
within the jurisdiction of the SEC, as are other securities traded on such
exchanges. As a result, many of the protections provided to traders on
organized exchanges will be available with respect to such transactions. In
particular, all foreign currency option positions entered into on a national
securities exchange are cleared and guaranteed by the Options Clearing
Corporation (the "OCC"), thereby reducing the risk of counterparty default.
Further, a liquid secondary market in options traded on a national
securities exchange may be more readily available than in the
over-the-counter market, potentially permitting a Fund to liquidate open
positions at a profit prior to exercise or expiration, or to limit losses in
the event of adverse market movements.
The purchase and sale of exchange-traded foreign currency options,
however, is subject to the risks of the availability of a liquid secondary
market described above, as well as the risks regarding adverse market
movements, margining of options written, the nature of the foreign currency
market, possible intervention by governmental authorities and the effects of
other political and economic events. In addition, exchange-traded options on
foreign currencies involve certain risks not presented by the
over-the-counter market. For example, exercise and settlement of such
options must be made exclusively through the OCC, which has established
banking relationships in applicable foreign countries for this purpose. As a
result, the OCC may, if it determines that foreign governmental restrictions
or taxes would prevent the orderly settlement of foreign currency option
exercises, or would result in undue burdens on the OCC or its clearing
member, impose special procedures on exercise and settlement, such as
technical changes in the mechanics of delivery of currency, the fixing of
dollar settlement prices or prohibitions on exercise.
POLICIES ON THE USE OF FUTURES AND OPTIONS ON FUTURES CONTRACTS: In order to
assure that a Fund will not be deemed to be a "commodity pool" for purposes
of the Commodity Exchange Act, regulations of the CFTC require that a Fund
enter into transactions in Futures Contracts, Options on Futures Contracts
and Options on Foreign Currencies traded on a CFTC-regulated exchange only
(i) for bona fide hedging purposes (as defined in CFTC regulations), or (ii)
for non-bona fide hedging purposes, provided that the aggregate initial
margin and premiums required to establish such non-bona fide hedging
positions does not exceed 5% of the liquidation value of a Fund's assets,
after taking into account unrealized profits and unrealized losses on any
such contracts a Fund has entered into, and excluding, in computing such 5%,
the in-the-money amount with respect to an option that is in-the-money at
the time of purchase.
<PAGE>
----------
APPENDIX B
----------
DESCRIPTION OF BOND RATINGS
The ratings of Moody's, Standard & Poor's, Fitch and Duff & Phelps represent
their opinions as to the quality of various debt instruments. It should be
emphasized, however, that ratings are not absolute standards of quality.
Consequently, debt instruments with the same maturity, coupon and rating may
have different yields while debt instruments of the same maturity and coupon
with different ratings may have the same yield.
MOODY'S INVESTORS SERVICE, INC.
Aaa: Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to
as "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such
issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there may
be other elements present which make the long-term risk appear somewhat
larger than the Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may
be present which suggest a susceptibility to impairment some time in the
future.
Baa: Bonds which are rated Baa are considered as medium-grade obligations,
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable
over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance
of other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca: Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds, and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
STANDARD & POOR'S RATINGS SERVICES
AAA: An obligation rated AAA has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is EXTREMELY STRONG.
AA: An obligation rated AA differs from the highest rated obligations only
in small degree. The obligor's capacity to meet its financial commitment on
the obligation is VERY STRONG.
A: An obligation rated A is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than obligations in
higher rated categories. However, the obligor's capacity to meet its
financial commitment on the obligation is still STRONG.
BBB: An obligation rated BBB exhibits ADEQUATE protection parameters.
However, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
Obligations rated BB, B, CCC, CC, and C are regarded as having significant
speculative characteristics. BB indicates the least degree of speculation
and C the highest. While such obligations will likely have some quality and
protective characteristics, these may be outweighed by large uncertainties
or major exposures to adverse conditions.
BB: An obligation rated BB is LESS VULNERABLE to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which could
lead to the obligor's inadequate capacity to meet its financial commitment
on the obligation.
B: An obligation rated B is MORE VULNERABLE to nonpayment than obligations
rated BB, but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet
its financial commitment on the obligation.
CCC: An obligation rated CCC is CURRENTLY VULNERABLE to nonpayment, and is
dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation. In the event
of adverse business, financial, or economic conditions the obligor is not
likely to have the capacity to meet its financial commitment on the
obligation.
CC: An obligation rated CC is CURRENTLY HIGHLY VULNERABLE to nonpayment.
C: Subordinated debt or preferred stock obligation rated C is CURRENTLY
HIGHLY VULNERABLE to nonpayment. The C rating may be used to cover a
situation where a bankruptcy petition has been filed or similar action has
been taken, but payments on this obligation are being continued. A C rating
will also be assigned to a preferred stock issue in arrears on dividends or
sinking fund payments, but that is currently paying.
D: An obligation rated D is in payment default. The D rating category is
used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes
that such payments will be made during such grace period. The D rating also
will be used upon the filing of a bankruptcy petition or the taking of a
similar action if payments on an obligation are jeopardized.
PLUS (+) OR MINUS (-) The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
R: This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk -- such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
FITCH IBCA
AAA: Highest credit quality. AAA ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong capacity
for timely payment of financial commitments. This capacity is highly
unlikely to be adversely affected by foreseeable events.
AA: Very high credit quality. AA ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of
financial commitments. This capacity is not significantly vulnerable to
foreseeable events.
A: High credit quality. A ratings denote a low expectation of credit risk.
The capacity for timely payment of financial commitments is considered
strong. This capacity may, nevertheless, be more vulnerable to changes in
circumstances or in economic conditions than is the case for higher ratings.
BBB: Good credit quality. BBB ratings indicate that there is currently a low
expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and
in economic conditions are more likely to impair this capacity. This is the
lowest investment-grade category.
Speculative Grade
BB: Speculative. BB ratings indicate that there is a possibility of credit
risk developing, particularly as the result of adverse economic change
over time; however, business or financial alternatives may be available to
allow financial commitments to be met. Securities rated in this category
are not investment grade.
B: Highly speculative. B ratings indicate that significant credit risk is
present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is contingent
upon a sustained, favorable business and economic environment.
CCC, CC, C: High default risk. Default is a real possibility. Capacity for
meeting financial commitments is solely reliant upon sustained, favorable
business or economic developments. A CC rating indicates that default of
some kind appears probable. C ratings signal imminent default.
DDD, DD, D: Default. The ratings of obligations in this category are based
on their prospects for achieving partial or full recovery in a
reorganization or liquidation of the obligor. While expected recovery values
are highly speculative and cannot be estimated with any precision, the
following serve as general guidelines. DDD obligations have the highest
potential for recovery around 90% -- 100% of outstanding amounts and accrued
interest. For U.S. corporates, for example, DD indicates expected recoveries
of 50% -- 90%, and D the lowest recovery potential, i.e. below 50%.
DUFF & PHELPS CREDIT RATING CO.
AAA: Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA+, AA, AA-: High credit quality. Protection factors are strong. Risk is
modest but may vary slightly from time to time because of economic
conditions.
A+, A, A-: Protection factors are average but adequate. However, risk
factors are more variable and greater in periods of economic stress.
BBB+, BBB, BBB-: Below-average protection factors but still considered
sufficient for prudent investment. Considerable variability in risk during
economic cycles.
BB+, BB, BB-: Below investment grade but deemed likely to meet obligations
when due. Present or prospective financial protection factors fluctuate
according to industry conditions or company fortunes. Overall quality may
move up or down frequently within this category.
B+, B, B-: Below investment grade and possessing risk that obligations will
not be met when due. Financial protection factors will fluctuate widely
according to economic cycles, industry conditions and/or company fortunes.
Potential exists for frequent changes in the rating within this category or
into a higher or lower rating grade.
CCC: Well below investment grade securities. Considerable uncertainty exists
as to timely payment of principal, interest or preferred dividends.
Protection factors are narrow and risk can be substantial with unfavorable
economic/industry conditions, and/or with unfavorable company developments.
DD: Defaulted debt obligations. Issuer failed to meet scheduled principal
and/or interest payments.
DP: Preferred stock with dividend arrearages.
<PAGE>
----------
APPENDIX C
----------
The funds are newly organized and do not have performance quotations as of the
date of this SAI.
<TABLE>
<CAPTION>
ACTUAL
30-DAY 30-DAY
AVERAGE ANNUAL TOTAL RETURNS YIELD YIELD CURRENT
------------------------------ (INCLUDING (WITHOUT DISTRIBUTION
1 YEAR 5 YEARS LIFE OF FUND ANY WAIVERS) ANY WAIVERS) RATE+
------ ------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Shares, at net asset value Not applicable
</TABLE>
<PAGE>
INVESTMENT ADVISER
Massachusetts Financial Services Company
500 Boylston Street, Boston, MA 02116
(617) 954-5000
(800) 637-2262
DISTRIBUTOR
MFS Fund Distributors, Inc.
500 Boylston Street, Boston, MA 02116
(617) 954-5000
CUSTODIAN AND DIVIDEND DISBURSING AGENT
State Street Bank and Trust Company 225
Franklin Street, Boston, MA 02110
SHAREHOLDER SERVICING AGENT
MFS Service Center, Inc.
2 Avenue de Lafayette, Boston, MA 02111-1738
Toll free: (800) 637-2262
MAILING ADDRESS:
P.O. Box 1400, Boston, MA 02104-9985
INDEPENDENT AUDITORS
Deloitte & Touche LLP
125 Summer Street, Boston MA 02110
MFS(R) INSTITUTIONAL TRUST
500 BOYLSTON STREET
BOSTON, MA 02116
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INVESTMENT MANAGEMENT
We invented the mutual fund(R)